What is Currency Strength?
Currency strength is the relative strength of a currency in comparison with others. It's measured by noting how many products or services you can buy with it, and how many foreign currencies you get when trading one unit of your currency.
It is difficult to determine the strength of a currency, as there are many factors at play. The three main areas examined in determining the strength of a currency include the demands from various countries, the interest rates from corresponding banks, and whether or not they have an equal balance in trade.
The Power of Currencies - Utility and relevance of currency as a financial asset
China is a prime example of how increased local production leads to a higher say in the international trade market. The additional boost of confidence will lead to an increase in the purchase power from local Chinese, which will fuel China's import and export market.
When countries trade with each other, they take their national currencies, which creates a demand for them among other countries. This increases the popularity of the currencies, making it possible to exchange them without the mediation of a stronger currency like the U.S. Dollar.
The U.S. Dollar is the strongest currency in the world because it has both a large consumer market and serves as the primary trade and reserve currency across the globe.
Of central bank reserves, 40% are denominated in dollars and around 60% of world trade is conducted in U.S dollars. However, many countries borrow in these currencies and earn revenue or taxes in their domestic currencies. Dollar strength can increase the risk of defaulting on debt and that's why it has been said that "The US-Dollar and Treasury Bonds have been the safest places to invest so far."
What is the best way to calculate currency strength?
The purchasing power of a currency is based on the income and wages that citizens make. This is to calculate the nominal earning and see how many goods and services can be bought locally.
The nominal income is then adjusted to the rate of inflation over a certain period of time, to find the value of the real income. Real incomes reflect the true economic value of earnings, which is adjusted for inflation.
With different currencies, the strength is measured in the U.S. Dollar and the Euro. These are both reserve currencies in the world and part of a Forex currency pair.
A country’s currency tends to reflect the global economic preference and trust in that country, which is affected by the global climate of trade, regional political conditions, and an economy’s internal performance.
In addition, in the emerging markets like Brazil or China, their strength is measured against a major reserve currency such as the U.S. dollar. For example, if the Chinese Yuan increased against the U.S. Dollar in the USD/CNY currency pair, it would indicate an improving Chinese economy and growing economic power worldwide.
One way to gauge the value of a currency is through a tool called the Dollar Index (Dixie). It’s also possible to trade on this measure with an index derivate in the ICE and it’s the most popular one. The weighted average price for an USD currency pair is the Euro, British Pound and more. The Euro is the strongest currency on the Dixie index at 57%.
What are currency strength indicators?
Whether you are going long or short, it is always useful to know the currency strength. These are 2 major technical indicators that measure the strength of a currency - absolute currency strength and relative currency strength.
The Relative Currency Strength indicator measures the strength of the major currencies across their 28 cross currency pairs. It is generated based on 14-period timeframes, but with values between 0 and 100. 70 shows strong momentum in the underlying currency, whereas 30 indicates weak momentum. The indicator can be used for both short and long term trading predictions.
Currency strength indicators include a variety of tools that can help trading session results. They are not the complete trading strategy based on CSI and should be accompanied by other information.