Currency strength index expresses the index value of currency. For economists, it is often calculated as purchasing power, while for financial traders, it can be described as an indicator, reflecting many factors related to the currency; for example, fundamental data, overall economic performance or interest rates. It can also be calculated from currency in relation to other currencies, usually using a pre-defined currency basket. A typical example of this method is the U.S. Dollar Index. The current trend in currency strength indicators is to combine more currency indexes in order to make forex movements easily visible. For the calculation of indexes of this kind, major currencies are usually used because they represent up to 90% of the whole forex market volume.
Contents
Currency strength based trading indicators
Currency strength is calculated from the U.S. Dollar Index, which is used as a reference for other currency indexes.
Percentage currency strength index on analytic platform.
The basic idea behind indicators is "to buy strong currency and to sell weak currency".
If is X/Y currency pair is up trend, you are able to determine whether this happens due to X's strength or Y's weakness.
With indicators of this kind one is able to choose the most valuable pair to trade; see the reactions of each currency on moves in correlated instruments (for example CAD/OIL or AUD/GOLD); look for a strong trend in one currency; and observe most of the forex market in one chart.
Examples
Typical examples of indicators based on currency strength are relative currency strength and percentage currency strength. Their combination is called the "Forex Flow indicator", because you are able to see the whole currency flow across the forex market.