Instead of speculating on a specific currency pair, a forex trader can elect to speculate on a forex index.
If you speculate on a specific pair, e.g. EUR/USD, the value of the EUR in relation to the USD is the only thing that matters for your bottom line. There are situations where a forex traders wants to have exposure to a certain currency, e.g. USD, but not only in relation to one specific other currency. In such a situation, speculating on a forex index can be a good choice. You may for instance believe that the USD will strenghten in general soon, but don´t want to bet everything on the specific EUR/USD relationship.
- 1 What is a forex index?
- 2 Examples of well-known forex indices
- 3 Commodity baskets
- 4 Volatility
- 5 Finding fx indices to speculate on
- 6 Costs
- 7 What is the USDX?
- 8 Advantages of using fx indices for fx speculation
- 9 Downsides of using fx indices for fx speculation
- 10 Is forex index speculation possible even for small-scale hobby traders?
What is a forex index?
A forex index is typically used to measure the value of a certain currency in relation to a basket of other currencies. The famous USDX index does for instance measure the value of the USD against a basket containing EUR, JPY, GBP, CAD, SEK, and CHF.
Sometimes, the currency basket is specifically compiled and weighted to represent a certain market sector, or the most important trade partners, or some other parameter.
Examples of well-known forex indices
- U.S. Dollar Index
- Euro Currency Index
- Swiss Franc Index
- Swedish Krona Index
- Norwegian Krone Index
There are forex indices available where the value of one currency is not measured against a basket of other currencies but against a basket of commodity prices.
The relationship between two currencies (e.g. EUR/SEK) tend to be more volatile than the relationship between one currency and a basket of other currencies (e.g. the EUR against a basket of USD, JPY, GBP, CAD, SEK, and CHF).
Finding fx indices to speculate on
The number of forex indices available for retail speculators is small compared to the number of available currency pairs. You can expect an online forex broker to offer a much smaller number of fx indices and fx pairs.
If you are a forex trader who is interested in speculating on fx indices, you may need to look around for a while and evaluate various brokers before you find one that is right for you. The forex broker you are currently using for standard currency pair speculation might no be ideal for your venture into forex index speculation.
It should also be noted that it can prove very difficult, or impossible, to find a forex index developed for speculation on one of the more exotic currencies.
If you are familiar with currency pair speculation, you are probably also aware that you can find tighter spreads and lower commissions for major currency pairs (e.g. USD/EUR) than for minors and exotics. In the same way, you can typically find better terms and conditions for speculating on the large and well-known forex indices, such as the USDX, compared to speculating on less known fx indices.
As always, it is important to find a broker where the spreads and other costs are suitable for your particular strategy. A broker suitable for one strategy can be unsuitable for another.
What is the USDX?
The U.S. Dollar Index, commonly known as the USDX, is one of the most well-known and widely used forex indices in the world. It was established by the United States Federal Reserve in 1973 and is managed by ICE Data Indices; a subdivision of the Intercontinental Exchange (ICE).
The USDX measures the value of the USD in relation to a weighted basket of currencies. The basket has contained the same six currencies since 1999 when the Euro replaced the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc.
This is what the basket looks like:
- 57.6% – Euro/US Dollar (EUR/USD)
- 13.6% – US Dollar/Japanese Yen (USD/JPY)
- 11.9% – British Pound/US Dollar (GBP/USD)
- 9.1% – US Dollar/Canadian Dollar (USD/CAD)
- 4.2% – US Dollar/Swedish Krona (USD/SEK)
- 3.6% – US Dollar/Swiss Franc (USD/CHF)
Advantages of using fx indices for fx speculation
- When you speculate on one currency pair, everything is about the market price of those two currencies in relation to each other. If you for instance speculate on USD/EUR, everything will hinge on how these two currencies perform in relation to each other. If you want to speculate on the strength of the USD, but get a more balanced valuation of the currency in relation to several other major currencies, an fx index is a better solution.
- When you speculate on a currency pair you get a very strong exposure to just two currencies. Example: You have reason to believe the Euro is about to get stronger, but if you speculate on the EUR/USD currency pair, you will automatically also get a strong exposure to the value of the USD. Therefore, there are situations where forex traders prefer to speculate on the value of the Euro against a basket of other major currencies; it decreases their exposure to the USD.
- Today, it is possible to find online brokers who offer affordable solutions for forex index speculation even for retail clients.
- Just because you speculate on an index instead of currency pair it doesn´t mean you can only use one type of instrument. On the contrary, there are quite a few derivatives based on forex indices, including Contracts for Difference (CFDs) and Futures.
Downsides of using fx indices for fx speculation
- As mentioned above, forex indices tend to be less volatile than currency pairs. For some trading strategies, this is a downside since they perform better in volatile situations.
- You always need to pay close attention to how the index is weighted. Otherwise, you might get less diversification than you think. In the USDX index mentioned above, the basket includes six different currencies, but the Euro is very dominant.
- There are hundreds of currency pairs available for speculation, but the selection of forex indices is much more limited. For exotic currencies, it can be very difficult – or even impossible – to find a suitable one.
- The trading hours for forex indices tend to be more limited than for currency pairs. Finding an index where the trading hours suit your schedule can be a challenge, especially if you are a hobby trader with very limited amount of time in your daily life to trade actively.
Is forex index speculation possible even for small-scale hobby traders?
Yes, there are brokers who offer forex index speculation even for very small bankrolls. As always, it is important to pick the right broker; one where you can make trades small enough to implement a suitable risk diversification strategy even when your total bankroll is small.
Always check the costs and how they would impact your particular trading strategy. A trader doing micro-sized trades can for instance not pick a broker that is charging big fixed fees on each trade, since those fees will eat up the profit.