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Understand How to Trade the Dollar Index

written by: Tim Plaehn•edited by: Rebecca Scudder•updated: 9/10/2011

The path of how to trade the U.S. dollar index is somewhat different that the widely used forex currency trading. Trading the dollar index offers the potential to profit from dollar value changes against the major global currencies with one trade.

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    U.S. Dollar Index Identified

    The U.S. dollar index measures the performance of the greenback against a basket of the major global currencies. How to trade the dollar index is different that trading currency pairs through one of the many different forex currency brokers. The dollar index is a composite of the U.S. dollar value against the Canadian dollar, euro, British pound, Japanese yen, Swiss franc and Swedish krona.

    A trader should decide how he wants to trade the index. Is he looking for a longer term position for or against the dollar? Or is the goal short term trading to profit from smaller moves in the index? The answers to these questions will indicate which product and market is the best choice for trading the dollar index.

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    Exchange Traded Funds

    Exchange traded funds -- ETFs -- that track the dollar index can be used for trades ranging from day trading up to a long term holding for or against the dollar. The dollar index funds may be used as a hedge to protect the value of a stock or bond portfolio.

    The PowerShares DB U.S. Dollar Bullish Fund, stock symbol UUP, is designed to increase in value if the U.S. dollar index as tracked by the futures market goes up. This is the ETF to pick if the trader expects the dollar to increase in value against the world currencies.

    The PowerShares DB U.S. Dollar Bearish Fund, symbol UDN, is the flipside to UUP and will increase in value if the dollar declines against the basket of currencies.

    UUP and/or UDN allow trading of the dollar index through a regular stock brokerage account. The combination of the two funds allows the trader to go either direction without the need to short sell. Maximum leverage would be 2 to 1 in a regular margin account or 4 to 1 in an account designated as pattern day trading.

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    Dollar Index Futures

    Currency Exchange by TheTruthAbout 

    Traders who are familiar and comfortable with futures trading can directly trade the U.S. dollar index futures contract, symbol USDX. Futures trading allows trades with or against the index with the same contract, by either going long or short to open a trade. The futures contract trades directly against the value of the U.S. dollar index which is widely reported by the financial press and website.

    The USDX contract is worth $1,000 times the value of the dollar index. In December, 2010 one contract was worth about $80,000 with the index at 80. The tick size for USDX is half a cent, which works out to $5.00 per contract. The required margin deposit is approximately $2,000.

    Trading the U.S. dollar index future provides a 20 to 1 leverage ratio. If the index changes value by one point, one USDX contract will show a profit or loss of $1,000. Note that the trader who made a bet in the wrong direction would have lost half of her margin deposit and would be required to have on deposit or add additional money in the trading account to keep the trade open.

    For more tips and strategies, be sure to check out the other items in Bright Hub's Collection of Forex Trading Guides.

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    PowerShares: Commodity and Currency Funds

    OptionsXpress: U.S. Dollar Index Futures

    Image credit: TheTruthAbout on Flikr, Creative Commons Attribution