A currency basket is a portfolio of selected currencies with different weightings. A currency basket is commonly used to minimize the risk of currency fluctuations. Another purpose is setting the market value of a currency.
An example of a currency basket is the European Currency Unit that was used by the European Community member states as the unit of account before being replaced by the euro. Another example is the special drawing rights of the International Monetary Fund.
A well-known method is the US dollar index, which is used by Forex traders. There are six currencies forming the index: five major currencies (Euro, Japanese yen, British pound, Canadian dollar, and Swiss Franc), and Swedish krona.
How it works
The currency basket can be used to avoid high currency volatility. Forex trading is based on the opposition of one currency against another. Thus, a big jump of either currency can create unpleasant circumstances for the trader. If a Forex investor chooses to trade the USD against many other currencies, they should use the US dollar index. Traders can compose their own baskets with different weights and apply them to any trading strategy.
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