The dollar is the reserve currency of the world. This means that most central banks hold the dollar as part of their foreign exchange reserves. Part of the reason for this is the strength of the American economy, the democratic nature of the country, and the perceived stability.
The dollar index is the most widely used measure of the dollar strength. It measures it against the most liquid currencies. The weightings are shown in the table below.
To traders, understanding the price movements of the dollar index is very important. Part of this is that most commodities are priced in dollars. Therefore, a major strength in the dollar makes them more expensive.
As shown below, the dollar index started a major rally in mid 90s and peaked at $120 in 2002. It then underwent a major correction that brought it to a low of $71 in 2008 during the financial crisis. Between 2009 and 2010, the index traded in a range, establishing a double top position at $88. It then started a rally that ran until January 2017 before starting a correction.
This year, the dollar has started the year on a disappointing note. It has weakened against major currency pairs despite favorable economic data from the United States.
Before Christmas, Trump signed the massive tax reform package. On Wednesday, the Fed released their minutes that showed the tax reform package would help accelerate the GDP growth. Yesterday, ADP released its non-farm employment data that of 250K against the expected 190K. The country is experiencing full employment with the unemployment rate at 4.1%.
In the 6-month chart below, we can see that the index: touched the 4-month low of 90.97 on 7th September. It then started a rally until 7th November when it touched $95.14 before starting a decline. At the end of November, the index tried to recover, establishing double bottoms. However, the rally was not forthcoming and the index resumed its decline.
The dollar index has fallen, risen, and fallen again to form what seems like a double bottom as shown below.
Technical indicators – RSI, ADX, and Stochastic – give a neutral stance on the index. Traders should therefore may wait for a while before starting short or long entry positions on the index.