The Personality and Performance of the U.S. Dollar

Gaining a fundamental understanding of the U.S. economy is a critical part of being
prepared fundamentally for forex trading. The U.S. economy is still the largest
developed economy in the world, and therefore the U.S. dollar reflects this importance.
Much of the world’s trade is denominated in dollars, and global reserves of
central banks hold over US$4 trillion, which is about 60 percent of all reserves, according
to latest data. It is true that we are in a period when the world economy is growing,
particularly with the growth of Asia. This growth may mean that in the coming years,
the preeminence of the U.S. economy will diminish. However, as the U.S. economy remains
the critical pivot point of the world economy, forex trading will continue to pay
close attention to U.S.-based economic events. In particular, the forex trader, in trading
a currency pair involving the dollar, is actually making a judgment or a bet about the
direction of the U.S. dollar with regard to the other pair. This can be a five-minute bet or
one that goes substantially longer in duration. But the fundamental question the trader
has to answer is whether to be bullish or bearish on the dollar for his next trade.
A first approach to getting a picture of the global position of the U.S. dollar and
gauging whether it is strong or weak is by looking at the Trade-Weighted Index (TWI).
In Figure 8.1 we can see that the “health” of the U.S. dollar has declined significantly.
It is probing the lows of this index, and if it breaks below 80, the world, through global
trading forces, will demonstrate an unprecedented decline in dollar values.
This 30-year chart certainly provides a perspective missing from day-to-day trading,
but a forex trader can zoom in on the U.S. dollar performance by generating a nearerterm
chart. For example, in Figure 8.2, we see the U.S. Dollar Index–TWI recent patterns.
The trader can use this chart and generate strategies to prepare for future moves if they
occur. The next time you are asked the question, “What do you think of the U.S. dollar?,” based on a review of Figure 8.2, you can answer that the U.S. dollar is in a compressed
triangle and that it is testing historic support near 80 on the TWI. One can also go further
and develop a trading strategy and state: “If it breaks below 80, I will be a seller of dollars,
but if it stays above it, I will be a buyer.” This kind of strategy, which comes from a
fundamental perspective but also reflects good technical strategy, is a recipe for success.
Gaining insight into the strength of the U.S. dollar can also be done by looking at the
New York Board of Trade’s (NYBOT’s) U.S. Dollar Index (USDX). This index is traded
at the NYBOT and is a weighted index. It is not trade weighted and therefore does not
reflect the dollar’s strength or weakness in the context of global trading patterns. But the
USDX is traded by major funds and is considered an important barometer of sentiment
regarding the dollar. It can easily be tracked at www.ino.com. Let’s take a closer look.






By ABE COFNAS