InvestZ Archives | Page 128 of 160

Aug

2023

Implied Volatility: What It Is & What It’s Used for

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Implied volatility (IV) is a metric that describes the market’s expectation of future movement in the price of a security. Implied volatility, also known by the symbol σ (sigma), employs a set of predictive factors to forecast the future changes of a security’s price.

Investors sometimes use implied volatility as a way to understand the level of market risk they face. They calculate the implied volatility of a security using either the Black-Scholes model or the Binomial model.

What Is Volatility?

Volatility, as it relates to investments, is the pace at which the market price of a security moves up or down during a given period. During times of high volatility, prices experience frequent, large swings.

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What Is Implied Volatility?

Implied volatility is, in essence, a prediction, based on probability. While it shapes the price of an option, it does not guarantee that the price activity of the underlying security will indeed be as volatile, or as stable, as the expectation embedded in its implied volatility. While implied volatility isn’t a window onto the future, it does often correlate with the broader opinion that the market holds regarding a given security.

To express implied volatility, investors typically use a percentage that shows the rate of standard deviation over a particular time period. As a measure of market risk, investors typically see the highest implied volatility during downward-trending or bearish markets, when they expect equity prices to go down.

During bull markets on the other hand, investors implied volatility tends to go down as more investors believe equity prices will rise. That said, as a metric, implied volatility doesn’t predict the direction of the price swings, only that the prices are likely to swing.

How Implied Volatility Affects Options

So how does implied volatility affect options? When determining the value of an options contract, implied volatility is a major factor. Options implied volatility can also help options traders decide whether and when to exercise their option.

An investor buying options contracts has the right, but not the obligation, to buy or sell a particular asset at an agreed-upon price during a specified time period. Because IV options forecast the size of the price change investors expect a security to experience in a specific time span, it directly affects the price an investor pays for an option. It would not help them determine whether they want a call or a put option.

It can also help investors determine whether they want to charge or pay an options premium for a security. Options on underlying securities that have high implied volatility come with higher premiums, while options on securities with lower implied volatility command lower premiums.

Implied Volatility and Other Financial Products

Implied volatility impacts the prices of financial instruments other than options. One such instrument is the interest rate cap, a product aimed at limiting the increases in interest charged by variable-rate credit products.

For example, homeowners might purchase an interest rate cap to limit the risks associated with their variable-rate mortgages and adjustable-rate mortgage (ARM) loans. Implied volatility is a major factor in the prices that people pay for those caps.

How Is Implied Volatility Calculated?

There are two implied volatility formulas that investors typically use.

Black-Scholes Model

One of the most widely used methods of calculating implied volatility is the Black-Scholes Model. Sometimes known as the Black-Scholes-Merton model, the Black-Scholes model is named for three economists who developed the model in 1973.

It is a complex mathematical equation investors use as a way of projecting the price changes over time for financial instruments, including stocks, futures contracts, and options contracts. Investors use the Black-Scholes Model to forecast different securities and financial derivatives. When used to price options, it uses the following factors:

• Current stock price

• Options contract strike price

• Amount of time remaining until the option expires

• Risk-free interest rates

The Black-Scholes formula takes those known factors and effectively back-solves for the value of volatility.

The Black-Scholes Model offers a quick way to calculate European-style options, which can only be exercised at their expiration date, but the formula is less useful to accurately calculating American options, since it only considers the price at an option’s expiration date. With American options, the owner may exercise at any time up to and including the expiration day.

Recommended: The Black-Scholes Model, Explained

Binomial Model

Many investors consider the binomial option pricing model more intuitive than the Black-Scholes model. It also represents a more effective way of calculating the implied volatility of U.S. options, which can be exercised at any point before their expiration date.

Invented in 1979, the binomial model uses the very simple assumption that at any moment, the price of a security will either go up or down.

As a method for calculating the implied volatility of an options contract, the binomial pricing model uses the same basic data inputs as Black-Scholes, along with the ability to update the equation as new information arises. In comparison with other models, the binomial option pricing model is very simple at first, but becomes extremely complex as it accounts for multiple time periods.

By using the binomial model with multiple periods of time, a trader can use an implied volatility chart to visualize the changes in implied volatility of the underlying asset over time, and evaluate the option at each point in time. It also allows the trader to update those multi-period equations based on each day’s price movements, and new market news emerges.

The calculations involved in the binomial model can take a long time to complete, which makes it difficult for short-term traders to utilize.

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What Affects Implied Volatility?

The markets fluctuate, and so does the implied volatility of any security. As the price of a security rises, that can change its implied volatility, which translates to changes in the premium it costs to buy an option.

Another factor that changes the implied volatility priced into an option is the time left until the option expires. An option with a relatively near expiration date will have lower implied volatility than one with a longer duration. And as an options contract grows closer to its expiration, the implied volatility of that option tends to fall.

Implied Volatility Pros and Cons

There are both benefits and drawbacks to be aware of when using implied volatility to evaluate a security.

Pros

• Implied volatility can help an investor quantify the market sentiment around a given security.

• Implied volatility can estimate the size of the price movement that a particular asset may experience.

• During periods of high volatility, implied volatility can help investors choose safer sectors or products.

Cons

• Implied volatility cannot predict the future.

• Implied volatility does not indicate the direction of the price movement a security is likely to experience.

• Implied volatility does not factor in or reflect the fundamentals of the underlying security, but is based entirely on the security’s price.

• Implied volatility does not account for unexpected adverse events that can affect the security, its price and its implied volatility in the future.

The Takeaway

Investors use implied volatility to predict the changes in security prices that increase the odds of success. It is a useful indicator but it has limitations, so investors may want to use it in connection with other types of analysis.

Volatility is a fairly high-level concept as it relates to the markets, and given that there are different types of volatility, it may be beyond most investors’ ability to properly use as a part of a larger strategy. That said, having a basic understanding of implied volatility can be useful for nearly all investors.

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Aug

2023

What Is a Death Cross Pattern in Stocks? How Do They Form?

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

A death cross is the X-shape created when a stock’s or index’s short-term moving average descends below the long-term moving average, possibly signaling a sell-off. The death cross typically shows up on a technical chart when the 50-day simple moving average (SMA) of a stock or index peaks, drops, and then crosses below the 200-day moving average.

Because the 50-day SMA is more of a short-term indicator, it’s considered to be a more accurate indicator of potential volatility ahead than the 200-day SMA, which has averaged in 200 days worth of prices. That said, both the 50-day moving average and the 200-day are, by definition, lagging indicators. Meaning: They only capture what has already happened. Still, some death crosses have appeared to forecast major recessions — although they can also send false signals.

What Is a Death Cross, Exactly?

A death cross is based on a technical analysis of a security’s price. The short-term average dropping below the long-term average to create an X-shape is the “cross”; the “death” part of the name refers to the ominous signal that such a crossing may send for individual securities or overall markets.

A death cross tends to form over the course of three separate phases. In the first phase, the rising value of a security reaches its peak as the momentum dies down, and sellers begin to outnumber buyers. That brings on the second phase, in which the price of the security begins to decline to the point where the actual death cross occurs.

That’s typically marked as being when the security’s 50-day moving average dips under the 200-day moving average.
That crossing alerts the broader market to a potential bearish, long-term trend, which brings about the third and final phase of the death cross. In this phase, the stock may continue to lose value over a longer period.

If the dip following the cross is short-lived, and the stock’s short-term moving average moves back up over its long-term moving average, then the death cross is usually considered to be a false signal.

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What Does the Death Cross Tell Investors?

The death cross has helped predict some of some of the worst bear markets of the past 100 years: e.g., in 1929, 1938, 1974, and 2008. Nonetheless, because it’s a lagging indicator, meaning that it only reveals a stock’s past performance, it’s not 100% reliable.

Another criticism of the death cross is that the pattern sometimes won’t show up until a security’s price has fallen well below its peak. In order to alter a death cross calculation to see the downtrend a little sooner, some investors say that a death cross occurs when the security’s trading price (not its short-term moving average), falls under its 200-day moving average.

For experienced traders, investors, and analysts, a death cross pattern for a stock is most meaningful when combined with, and confirmed by, other technical indicators.

When interpreting the seriousness of a death cross, experienced investors will often look at a stock’s trading volume. Higher trading volumes during a death cross tend to reveal that more investors are selling into the death cross, and thus buying into the downward trend of the stock.

Investors will also look to technical momentum indicators to see how seriously to take a death cross. One of the most popular of these is the moving average convergence divergence (MACD), which is based on the moving averages of 15, 20, 30, 50, 100, and 200 days, and is designed to give investors a clearer idea of where a stock is trading than one that’s updated second by second.

Death Cross vs Golden Cross: Main Differences

The opposite of a death cross is known as a golden cross. The golden cross indicator is when the 50-day moving average of a particular security moves higher than its 200-day moving average.

While the golden cross is broadly considered a signal of a bull market, it has some of the same characteristics as the death cross in that it’s essentially a lagging indicator. Experienced investors use the golden cross in conjunction with other technical indicators such as trading volume and MACD.

Is a Death Cross a Reliable Indicator?

Historically, the death cross indicator has an impressive track record as a barometer of the broader stock market, especially when it comes to severe downturns, as noted above.

The Dow Jones Industrial Average (DJIA) went through a death cross shortly before the crash of 1929. More recently, the S&P 500 Index underwent a death cross in May of 2008 – four months before the 2008 crash. In both instances, investors who stayed in the market faced extreme losses. But the Dow also experienced a death cross in March of 2020. And the markets quickly rebounded, and rose to new heights.

The fact is that broad-market death crosses happen frequently. Prior to 2020, the Dow has gone through five death crosses since 2010, and 46 death crosses since 1950. Yet the index has only entered a bear market 11 times since the 1950s. A death cross doesn’t necessarily bring significant losses, either.

Even more noteworthy is that the Dow continued falling after a death cross only 52% of the time since 1950. And when it did keep falling, its median decline after a month was only 0.9%.

For short-term traders, the death cross has less value than it does for investors with longer-term outlooks. As an indicator, the death cross – especially one that’s market-wide – can be especially valuable for long-term investors who hope to lock in their gains before a bear market begins.

How to Trade a Death Cross

The death cross is a significant indicator for some investors. But it’s important to remember that it only shows past trends. As an investor, it’s equally important to use the death cross in conjunction with other indicators such as the MACD and trading volume, as well as other news and information related to the security you’re investing in.

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The Takeaway

Although the ominous-sounding death cross stock pattern is valued by some analysts and investors as a way to foretell a downturn in a certain security or even the broader market, it’s really not that reliable. The main elements of the death cross — a stock’s short-term moving average and long-term moving average — are lagging indicators that may or may not predict a bearish turn of events.

The typical investor may not use or even look for death crosses as a part of their strategy. But knowing, on a basic level, what the term refers to, and why it may be important to the markets, is a good idea.

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Aug

2023

Lidar Stocks: What Are They & How Do You Pick the Best Ones?

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Many people associate “Lidar” with the sensors that enable self-driving cars — but there are a growing number of applications for this technology that can offer attractive new opportunities for investors. New developments in self-driving cars and other smart products are driving demand for Lidar technology, which is in turn helping to spur the growth of Lidar companies innovating in this space.

What Is Lidar? How Is it Used?

Lidar is short for “light detection and ranging,” and Lidar works by using short bursts of light from lasers to create a 3-D rendering of an object or environment.

Devices equipped with Lidar detect nearby objects, and process massive amounts of data to determine information such as their size, direction and speed of movement — which is why Lidar has become a core technology in the sensors that may one day allow self-driving cars to operate safely.

What many people don’t know is that Lidar is also at work in the newest smartphones and other automated devices like robot vacuum cleaners, which use Lidar to scan the environment and maneuver through a room.

Lidar is also widely used for measurement and imaging in an array of scientific disciplines, including oceanography, archaeology, forestry, seismology, robotics and atmospheric physics. For that reason, some lidar technology stocks attract investor interest.

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The Advantages of Lidar

Lidar offers several advantages over similar technologies, such as radar, because light has a shorter wavelength than radio waves. By sending out repeated laser bursts, Lidar can offer a clearer picture of a given target.

For example, the Lidar sensors on some smartphones can give users almost instantaneous estimates of the size, shape and distance of an object, a capability that has enabled better experiences of augmented reality.

Also, as the Internet of Things (IoT), an element of Web 3.0, moves toward increasingly autonomous and interconnected machines, those devices will likely need sophisticated sensors to operate safely and effectively, which is another reason why Lidar companies and Lidar stocks are catching the eye of investors large and small.

Some Lidar Drawbacks

That said, investors considering Lidar technology stocks should be aware of some of the drawbacks as these may present some investment risks. Although Lidar technology can be highly sophisticated, critics note that some Lidar systems can lag in a more dynamic environment (e.g. driving in traffic), where a swift analysis of driving conditions is critical to safety.

Another drawback is that some Lidar sensors may weigh all data points equally in a given environment, and fail to take into account a more present danger like a certain obstacle or bad weather. For example: Lidar functionality has also been compromised by rainy or cloudy conditions, or very bright sun — as any of these can interfere with the light reflection and refraction that’s fundamental to the technology.

Lidar Stocks to Watch

Given the growth of the industry, and industries utilizing Lidar technology, there are numerous lidar stocks on the market. While investors will likely come up with a list by engaging in a quick internet search, it’s important to remember that Lidar is a developing technology, and that all stocks have associated risks. In short: Be sure to do your homework before investing in Lidar stocks.

Evaluating Potential Investment Risks With Lidar Stocks

Lidar has been finding its ways into the products people use on a daily basis, and it holds great promise as an enabler for many technologies in many different fields. As such, investors may find investment opportunities through one or several public Lidar companies.

But investing in Lidar stocks comes with some risks. One risk factor investors should consider: a single version of Lidar technology might emerge as a frontrunner, elevating one patent-holding company to prominence and relegating others to the status of also-rans. On the flip side, there is also the risk that one company’s technology might be adopted, but not widely.

And while Lidar is seen by many as an essential technology in self-driving cars, there is some debate on this point, with reports indicating that some automakers are exploring other types of sensors and networks to create safe, viable autonomous vehicles.

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The Takeaway

Lidar technology and sensors are well-entrenched in the autonomous car market, and now a growing number of companies are finding innovative ways to use this laser-driven technology to make advancements in other industries — like oceanography, seismology, robotics and more.

While the expanding array of players in the Lidar space may be contributing to a sense of excitement about what the future of Lidar may hold, competing companies and technologies also indicate that this is a sector that’s still in flux, and there is much for investors to weigh when it comes to choosing the best Lidar stocks.

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Aug

2023

What Is Volume in Stock Trading? How Investors Can Use It

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

Stock trading volume is a measure of the amount of stocks traded over a given day or other specified time period. When more of a stock is traded actively, trading volume is high, while volume slumps as sales slow.

Some investors may analyze volume as a part of a technical analysis strategy to help them make decisions about when to buy and sell a particular stock. Here’s a closer look at volume and how investors may be able to use it.

What Is Volume in Stocks?

Trade volume for stock and other securities tells investors how frequently shares in a company are being bought and sold.

Every buy and sell transaction of a particular stock helps contribute to its trade volume. A transaction takes place when a buyer agrees to purchase the shares a seller has put up for sale. If this type of transaction takes place 100 times during a day for a particular stock, that stock has a trade volume of 100.

For stock futures and options trading, volume is based on how many contracts change hands during the set period.

Volume doesn’t tell the whole story of a stock. There are a couple of terms that can help give investors a better idea of the size of a company and how many shares are actually available, including “float” and market capitalization, or market cap.

Volume vs Float

While volume is the number of shares that are being actively traded during a given period, float is the number of shares that are actually available to trade. This total does not include restricted shares, which are not registered and are usually given to corporate leaders as part of a compensation package. Outstanding shares refers to all of the stock a company has issued, including restricted shares.

Stocks that have a small number of shares — usually between 10 million and 20 million — available to trade are what is known as “low-float” stocks. Large corporations, by contrast, could have floats of billions of shares.

In certain circumstances when trade volume is very high, volume can surpass float or even number of outstanding shares.

Volume vs Market Cap

Market cap is the total number of outstanding shares multiplied by the current public market price. In other words, it’s the dollar amount required to buy up all outstanding shares of a company, including restricted shares.

Market cap helps investors understand the size of one company relative to another. For example, large-cap stocks tend to be companies worth $10 billion to $200 billion, while small-cap stocks tend to be companies worth $250 million to $2 billion.

Investors can calculate free-float market cap by excluding restricted shares.

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What Does Stock Volume Tell You?

Stock volume tells investors how much interest there is in a stock. The greater the volume, the more interest there is, while smaller volume translates to less interest.

High trade volume can also indicate that stock orders are being executed quickly and that the market is highly liquid. In other words, high volume can mean that buying and selling the stock is relatively easy.

What It Means When Stock Volume Goes Up

When stock volume is on the rise, it typically means that prices are on the move, either in the upward or downward direction. As volume increases, it can mean that investors are committing to the price change; a trend may be gathering strength.

Generally speaking, higher volume means that there’s increased interest in buying a stock, and that the market for that stock is more liquid, making it easier to buy and sell shares.

What It Means When Stock Volume Goes Down

When stock volume starts to decrease, it can signal that investors are less enthusiastic about a company. Volumes can decrease even as stock prices increase.

Low volume can be a signal for investors to get cautious about a stock. It can signal market uncertainty, the possibility of stock volatility on the horizon, and lower liquidity.

Where Can You Find Stock Volume on a Chart?

Investors can usually find information about volume next to or below the stock chart provided by trading platforms or media sources, like Yahoo Finance or the Wall Street Journal.

Often volume is charted using a candlestick chart, in which investors look for patterns to help make investment decisions. Normally, candlestick charts measure a stock’s price, including highs, lows, and opening and closing prices over a given period. The resulting figure looks a bit like a candle with a line, or “wick”, that represents highs and lows and a rectangle that marks opening and closing prices. Volume candlestick charts use the width of the rectangle to indicate volume. The higher the volume, the wider the candle.

How Traders Can Use Volume

We’ve already seen that volume can help investors understand when a price trend is picking up steam. There are a few other basic guidelines investors may want to consider as they’re deciding when to buy and sell stocks.

Exhaustion Moves

Exhaustion moves occur when there is a sharp movement in the price of stock coupled with a sharp increase in trading volume. This potentially signals the end of a current price trend. These moments can be accompanied by a period of volatility.

Price Reversals

If the price of a stock has moved in one direction for a long time and volume begins to increase at the same time that prices start to move very little, it can signal a reversal. So if stock prices were on an upward trajectory, changes start to slow and volume increases, it might mean the trend is about to reverse.

Breakouts

A breakout is a point at which changes in market trends occur. Changes in volume can clue investors into the strength of the breakout. Little change in volume suggests investors are paying the breakout little heed, while big changes in volume indicate a strong new trend.

Bullish Signals

Volume can also help investors identify bullish signs that suggest prices are likely to rise. For example, say stock prices increase and then decline. At the same time there is an increase in volume which drives prices up again. The stock again declines, but if it doesn’t decline the second time as much as it did the first time, it may be a bullish signal that prices will continue to rise.

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Types of Indicators to Measure Stock Volume

There are a number of volume indicators that could help traders make investment decisions based on their approach and goals. Here are a few examples.

On Balance Volume (OBV)

On balance volume is a cumulative technical indicator in which volume is added on days when overall volume is up and subtracted on days when overall volume is down. The direction of the indicator is what is most important to investors. When price and OBV are moving up or down together, it is likely the trend will increase in strength.

Volume Price Trend (VPT)

Similar to OBV, volume price trend measures cumulative volume. However, it differs in that it considers a percentage increase or decrease in price. VPT helps investors relate share price to trading volume. If the price of a stock increases, so does the value of the indicator. If prices fall, the indicator value falls, too.

Ease of Movement

This indicator helps traders see how easy it is for a stock price to move between levels based on trading volumes. Stocks that continue along a trend for a given period are considered “easy.” This indicator is used over longer time periods and in volatile markets in which it can be hard to spot trends.

The Takeaway

Stock trading volume measures the amount of stocks traded in a given day or time period. Examining volume and other tools in technical analysis can help investors make decisions about when to buy and sell stocks.

When buying any individual security, investors should be sure to consider how it fits into their overall financial plan, including their goals, risk tolerance, and time horizon.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Aug

2023

What Is the US Dollar Index?

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

The U.S. dollar index, also called the USDX, tracks the value of the dollar compared with six major world currencies — specifically those of the United States’ most significant trading partners.

The USDX fluctuates based on the exchange rates that the dollar maintains with those currencies. Investors and traders use the USDX as a quick way to track the relative value of the dollar and to manage potential currency risks in their portfolio.

There are also several futures and options strategies trading on the New York Board of Trade that allow sophisticated investors to bet that the USDX will go up or down. For investors who want to hedge their currency risks, or just speculate, they can invest in the U.S. dollar index through mutual funds, exchange-traded funds (ETFs), or options.

How the US Dollar Index Is Calculated

Currently, the U.S. dollar index is calculated using the exchange rates of six currencies: the Euro (EUR), the Japanese yen (JPY), the Canadian dollar (CAD), the British pound (GBP), the Swedish krona (SEK), and the Swiss franc (CHF). Given that 19 countries in the European Union use the euro, EUR is the most significant component of the index, representing 57.6% of the basket.

By contrast the yen comprises 13.6% of the index, followed by the British pound (11.9%), the Canadian dollar (9.1%), the Swedish krona (4.2%), and finally the Swiss franc (3.6%).

The U.S. dollar has long been considered the world’s reserve currency, and the index tracks where five of those six currencies stood in relation to the U.S. dollar in 1973 (the euro was added to the index in 1999). At its inception, the U.S. dollar index was set at 100. When the index is over 100, then the dollar is considered strong, and it may be considered weak depending on how far below 100 it falls.

The strength or weakness of a dollar impacts many aspects of the economy. A weak dollar increases the prices that companies pay for globally traded commodities, which contributes to inflation by raising the prices consumers pay for everyday items. A strong dollar makes the goods produced in the U.S. more expensive to overseas consumers, and can hurt exports over time.

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The History of the US Dollar Index

When World War II ended in 1945, the United States found itself in a position of unusual strength. Like many countries, the U.S. had suffered enormous casualties, yet its industries, cities, and overall economy had survived the war more or less intact. So it was that in July of 1944, over 700 delegates from 44 countries met in Bretton Woods, NH, to create a roadmap for a more efficient foreign exchange system that would help establish a resilient post-war global economy.

The Bretton Woods Agreement that emerged from this historic conference created a system whereby gold became the basis for the U.S. dollar, and other currencies were pegged to the value of the dollar. The International Monetary Fund and the World Bank were also established as a result of Bretton Woods.

The new global currency system included a promise from the participating countries that their central banks would establish fixed exchange rates between their own currencies and the U.S. dollar. Each agreed that if their currency weakened, they would order their central bank to buy up the currency until its value stabilized relative to the dollar. And if their currency grew too strong compared with the dollar, their central bank would issue more currency until the value dropped and its relationship with the dollar stabilized.

The terms of the Bretton Woods Agreement were so far-reaching that it took until 1958 to be fully implemented. Still, the decision to keep the dollar pegged to gold proved challenging for the U.S. In 1971, when the gold owned by the U.S. government could no longer cover the number of dollars in circulation, President Richard M. Nixon was forced to reduce the dollar’s value relative to gold. The Bretton Woods System collapsed in 1973.

With the end of the Bretton Woods System, countries and their central banks took a wide range of approaches to how they valued their currency. After 1973, each country’s currency had its own value, adjusted through trade, government interventions, and the policies of central banks. To track the value of the dollar against this backdrop of currency valuations, the U.S. dollar index came into being.

When it launched, it had a base of 100, representing the dollar’s value versus the currencies of its major trading partners. Since then, the index has fluctuated relative to that base. Over the last five years, for example, the U.S. dollar index reached a high of 102.39 on December 1, 2016, and a low of 89.13 on January 1, 2018. The value of the index is considered a fair indication of the dollar’s position in global markets. And investors can also use it to trade.

💡 Quick Tip: How to manage potential risk factors in a self directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

How to Trade the US Dollar Index

Investors who want to bet on the rise or fall of the dollar’s value, or who simply want to hedge it as part of a broader strategy, can trade the U.S. dollar index the same way they trade an equity index like the S&P 500. The U.S. dollar index is popular among foreign exchange (FX) traders who don’t have the time or resources to monitor the movements between the dollar and the other currencies in the index.

Anyone who tracks global trade will notice that two major currencies are missing from the index: Neither the Chinese yuan (CNY) or the Mexican peso (MXN) are in the USDX. Historically the USDX has only been adjusted once since its inception — in 1999 when the euro was added, and certain of the currencies the euro had replaced were then removed from the index. Still, it’s likely that at some point the USDX could be adjusted a second time to include CNY and MXN, given their status as significant trading partners with the United States.

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Most investors know that a bond index or equity index is typically comprised of many constituent companies; similarly, the U.S. dollar index is comprised of six global currencies. It tracks the value of the dollar relative to those currencies, and fluctuates based on the exchange rates that the dollar maintains with those currencies. You can use the USDX as a way to track the relative value of the dollar, to manage potential currency risks in a portfolio, and to trade.

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Photo credit: iStock/FG Trade

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