The US Dollar Index (DXY) as an auxiliary indicator for trading in commodity currencies
The US dollar index (DXY) is a very significant index for the global FOREX market and is a weighted index of the US dollar against a basket of world currencies such as: EUR – 57.6%; GBP – 11.9%; JPY – 13.6%; CAD – 9.1%; CHF – 3.6%; SEK – 4.2%. Where interest is the weight ratio of a currency in the US dollar index. More information about the US dollar index, as an auxiliary indicator can be found here. This article focuses on the US dollar index (DXY) as an auxiliary indicator for trading against commodity currencies. Or rather, currency pairs containing the commodity currency and the US dollar.
The main essence of using the US dollar index for trading in commodity currencies is its use as a parameter of market sentiment. It is not a secret to anyone that commodity currencies depend largely on the overall dynamics of commodity assets:
- energy resources (oil, gas, coal, etc.)
- metals (copper, aluminum, etc.)
- food products (wheat, corn etc).
The three above categories are the main. At the same time, there are a lot of subcategories and they should be considered in terms of a specific commodity currency. So specifically taken commodity currency to a greater extent depends on one and less from other commodity assets. More information on commodities affecting the commodity currency can be determined by looking at the export of the country of the traded currency.
Simply put, the whole principle of this approach is a relation of raw materials price and commodity currencies to the US dollar. As a rule, this relationship has an inverse correlation, it means that with the strengthening of the cost of raw materials, the US dollar decreases and the commodity currency grows and vice versa. The change in the price of raw materials and commodity currencies depends on many factors. But the concept of risks is more accepted and generalized. With the growth of optimism in the market of raw materials and commodity currencies are growing. It is associated with an increase in demand for more profitable assets.
Of course, this principle does not include geopolitical factors and macroeconomic indicators. As a result, in certain conditions of slowing down the economy or other difficulties, the commodity currency may remain under pressure despite the growth of raw materials. This should be taken into account in this approach.
An example confirming this theory is the movement of the USD/CAD currency pair in comparison with BRENT oil, as the raw material asset on which the Canadian dollar and the US dollar index depend.
The graph above shows the dynamics of the USD/CAD currency pair (Japanese candles), Brent oil (blue line) and the US dollar index chart (green line)
This pattern is shown clearly from October 2018 to January 2019, where the inverse correlation between oil and the US dollar can be traced.