U.S. Dollar Index
A practical example of a weighted index is the U.S. Dollar Index, traded on the New York Futures Exchange. In order of greatest weighting, the 10 currency components are the Deutschemark 20.8%, Japanese yen 13.6%, French franc 13.1%, British pound 11.9%, Canadian dollar 9.1%, Italian lira 9.0%, Netherlands guilder 8.3%, Belgian franc 6.4%, Swedish kroner 4.2%, and the Swiss franc 3.6%. This puts a total weight of 75.5% in European currencies with only the Japanese yen representing Asia, not a practical mix for a world economy that has become dependent on Far Eastern trade. Within Europe, however, allocations seem to be proportional to the relative size of the economies.
The Dollar Index rises when the U.S. dollar rises. Quotes are in foreign exchange notation, where there are 1.25 Swiss francs per U.S. dollar, instead of .80 dollars per franc as quoted on the Chicago Mercantile Exchange’s IMM. For example, when the Swiss franc moves from 1.25 to 1.30 per dollar, there are more Swiss francs per dollar; therefore, each Swiss franc is worth less.
In the daily calculation of the Dollar Index, each price change is represented as a percent. If, in our previous example, the Swiss franc rises .05 points, the change is 5/12 5 04; this is multiplied by its weighting factor .208 and contributes +. 00832 to the Index.
THE INDEX
The purpose of an average is to transform individuality into classification. When done properly, there is useful information to be gained. Indices have gained popularity in the futures markets recently; the stock market indices are now second to the financial markets in trading volume. These contracts allow both individual and institutional participants to invest in the overall market movement rather than take the higher risk of selecting individual securities. Furthermore, investors can hedge their current market position by taking a short position in the futures market against a long position in the stock market.
A less general index, the Dow Jones Industrials, or a grain or livestock index can help the trader take advantage of a more specific price without having to decide which products are more likely to do best. An index simplifies the decision-making process for trading. if an index does not exist, it can be constructed to satisfy most purposes.