You will often hear from most traders whether they trade SMC, ICT, etc, that the currency pair EUR/USD and the DXY (US Dollar Index) are seen as inversely correlated. Often, not much reasoning is given as to why this is so this is what I will delve into. Take notes…

A huge factor in the inverse correlation is because of the way they are constructed and the economic relationship between the Euro and the US dollar. A basic overview that is also applicable to all currencies against the dollar is the following; The EUR/USD currency pair represents the exchange rate between the euro (EUR) and the US dollar (USD). When the value of the EUR/USD pair increases, it means that the euro has strengthened against the US dollar, and when it decreases, it means that the euro has weakened relative to the US dollar.

With DXY, however, this solely tracks as an index that measures the value of the US dollar against a basket of six major currencies, with the Euro having the highest weighting. The index is calculated by taking into account the exchange rates between the US dollar and these six currencies. These currencies are the following:

• Euro (EUR): 57.6%

• Japanese Yen (JPY): 13.6%

• British Pound (GBP): 11.9%

• Canadian Dollar (CAD): 9.1%

• Swedish Krona (SEK): 4.2%

• Swiss Franc (CHF): 3.6%

This is a major point because as a whole, this relationship exists because the Euro has the highest weighting in the DXY index, so any significant movement in the euro has a strong impact on the index as a whole.

Furthermore, the fact that the euro is the second most traded currency in the world does play a role in the inverse correlation between the EUR/USD and DXY. The euro is widely traded in the global foreign exchange market, and it is used as a reserve currency by many central banks and institutions. Its significant trading volume and liquidity make it an essential currency in the currency markets.

When there is increased demand for the Euro in the foreign exchange market, it will appreciate against other currencies, including the US dollar. This increased demand can be due to various factors such as positive economic data, interest rate differentials, or market sentiment. As mentioned earlier, several central banks around the world hold the euro as part of their foreign exchange reserves. The euro is considered one of the major reserve currencies alongside the US dollar, Japanese yen, and British pound.

You now have a better understanding of the relationship between the Euro and USD as a whole.