Understanding Dollar Strength

One of the economic indicators used by market players relates to the strength of the U.S. dollar. For investors, it can also be valuable because it can help determine how what investments to make.

Understand the dollar’s movement

To understand how to determine the dollar’s strength, first understand that it is based on the U.S. dollar index. This simply measures the value of the dollar as it relates to a basket of other currencies. These other currencies include the Euro, British pound, Swiss franc, and Japanese yen.

So, when it’s said that the dollar is weak, it means that its value decreased as compared to these other currencies. As noted by Investopedia:

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Essentially, a weak dollar means that a U.S. dollar can exchange for fewer amounts of foreign currency. The dollar may weaken due to changes in the interest rate and outlook on the U.S. economy’s future.



What causes movement?

The dollar can strengthen or weaken on various economic events. If a central bank, such as the Federal Reserve, decides to increase or decrease interest rates, the dollar’s value could be affected.

In the U.S., if the economy begins to roar along, the dollar will likely strengthen. Also, a robust economy typically sets the stage for an interest rate hike.

Then there are macroeconomic events that can affect the dollar’s move. In cases where there is a shift in government or policy makers, the perceived impact of any actions these people may take can be impactful. The anxiety, or optimism, by investors can cause moves in the dollar.

When the dollar strengthens

When the dollar strengthens, it’s best to be domestically invested. You want to be invested in these companies because their revenues will come the U.S.

As noted above, a strengthening dollar can reflect an improving economy. You want to be invested in the best stocks that are benefitting from the economy’s growth. For example consider blue chips they routinely rise and fall with the strengthening or weakening of the dollar.

On that same note, when the dollar is strengthening, you should avoid domestic companies whose profits are largely derived from overseas. This is because their revenues will likely be adversely affected as their foreign profits are negatively impacted.

Steer clear of companies that are heavily dependent on exports too because the strengthening dollar will cause their exported products to become more expensive, and thus less attractive.

Just keep in mind that as the dollar strengthens, it could lead to greater volatility in the equity markets.

When the dollar weakens

When some hear that the dollar is weak, they may think that’s bad news, especially if they are investors. However, that’s not necessarily the case.

In fact, a weak dollar can end up being a boon, depending on what you are invested in.

In environments in which the dollar has weakened, one of the most popular investments is in international stocks. As explained by CNBC:

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Usually, when people buy foreign stocks, their dollars get transferred into that country’s local currency. When those dollars appreciate in value, the investment gets a boost when converted back into U.S. funds.



In conclusion

When the dollar strengthens, attempt to lessen your exposure to foreign investments. Instead, increase your exposure to U.S.-based companies. A rule of thumb is to not panic and yank all of your investments so they have no foreign exposure.

Stay focused on the dollar average, and any movements that could affect the dollar. This includes pending Fed interest rate decisions, as well as policies of other central banks like the European Central Bank.

The key here is to make sure you stay abreast of anything that affects the economy because of their inevitable effects on the dollar.

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