The Forex market offers dozens of instruments that you can trade. But how to find an instrument that offers the best trading opportunity at the moment? This would be time-consuming and cumbersome to analyze all currency pairs. An alternative approach would be to use currency baskets.
One of the most known currency baskets is USDX created by the U.S. Federal Reserve in 1973. USDX is the ratio of the US dollar (USD) to a geometric average of the basket of six major foreign currencies – the Euro (EUR), the Japanese yen (JPY), the pound sterling (GBP), the Canadian dollar (CAD), the Swedish krona (SEK) and the Swiss franc (CHF).
The components of the instrument have the following weights:
- EUR: 57.6%
- JPY 13.6%
- GBP: 11.9%
- CAD: 9.1%
- SEK: 4.2%
- CHF: 3.6%
USDX has a number of disadvantages:
- the currency weights from 1973 are no longer relevant;
- the weight of the Euro is almost 60%, as a result, the instrument has a high correlation with EURUSD.
Better currency basket
But what if we create a basket per every currency and improve the formula by weighting all currencies equally. We created a basket with 8 major currencies - the US dollar (USD), the Euro (EUR), the Japanese yen (JPY), the pound sterling (GBP), the Swiss franc (CHF), the Canadian dollar (CAD), the Australian dollar (AUD), the New Zealand dollar (NZD). We add one unit of each currency. However, as we use the geometric average, the quantity of units doesn't matter as the geometric average represents the average rate of change. Hence, the currency basket would give a clear picture of the strength and momentum of every currency.
As a result, we could create the following currency baskets:
USDXXX - the US dollar versus the basket of 8 currencies
EURXXX - the Euro versus the basket of 8 currencies
JPYXXX - the Japanese yen versus the basket of 8 currencies
GBPXXX - the pound sterling versus the basket of 8 currencies
CHFXXX - the Swiss franc versus the basket of 8 currencies
CADXXX - the Canadian dollar versus the basket of 8 currencies
AUDXXX - the Australian dollar versus the basket of 8 currencies
NZDXXX - the New Zealand dollar versus the basket of 8 currencies
As an example, USDXXX is calculated with the formula:
USDXXX = (1/EURUSD × 1/GBPUSD × 1/AUDUSD × 1/NZDUSD × USDJPY × USDCAD × USDCHF) ** 0.125
Currency baskets offered by Finteria can be traded on the MetaTrader5 platform. These instruments help traders to get an exposure in a particular currency while reducing the complexity. In addition, these instruments are great for conducting technical analysis, identifying early trends and breakouts.