Recently, someone asked me what the U.S. dollar index really is, and I found that many people actually don’t understand it very well. Rather than thinking of it as something complicated, it’s better to think of it as a thermometer for the global financial markets.

Simply put, the U.S. dollar index measures how strong the U.S. dollar is relative to other major currencies. It doesn’t track stocks like the S&P 500. Instead, it tracks changes in the exchange rate between the U.S. dollar and six international currencies. These six currencies are the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc.

As for the components of the U.S. dollar index, the euro is the largest, accounting for more than 57%, which is why European economic trends have such a big impact on the dollar’s movement. The yen is second at about 13.6%, because Japan is the world’s third-largest economy. The remaining pound, Canadian dollar, Swedish krona, and Swiss franc together add up to less than 30%.

So when you hear “the U.S. dollar is strengthening” or “the U.S. dollar index is rising,” it essentially means the U.S. dollar has become more valuable compared with these currencies. Conversely, if the index falls, it means the U.S. dollar has weakened in the international market.

What effect does the rise and fall of the U.S. dollar index have on investing? My observation is that it can set off a chain reaction in asset prices. When the dollar appreciates, money usually flows back into the United States—U.S. stocks may benefit. But gold is often sold off, because gold is priced in U.S. dollars, and when the dollar is strong, the cost of buying gold increases. For Taiwan, a stronger U.S. dollar means that capital may flow out of Taiwan stocks, and the New Taiwan dollar is also more likely to depreciate.

There are several factors that determine whether the U.S. dollar index rises or falls. First is the Federal Reserve’s interest-rate policy: raising rates attracts global capital into the U.S., and the U.S. dollar strengthens. Second is U.S. economic data: if figures like employment, inflation, and GDP look good, the dollar is viewed more favorably. Third is geopolitics: the more chaotic things are, the stronger the U.S. dollar tends to be, because it’s treated as a safe-haven asset. Fourth is the movement of other currencies themselves. Sometimes it’s not the U.S. dollar that’s appreciating—rather, the euro or the yen is depreciating, and as a result, the U.S. dollar index appears to rise.

At this point, I’d like to mention that the Federal Reserve itself actually refers to the “U.S. Dollar Trade-Weighted Index” more often than the U.S. dollar index we usually see. The difference is that the U.S. dollar index is calculated using a fixed set of six currencies, while the trade-weighted index is weighted according to the countries with which the U.S. actually trades, including more than 20 currencies—such as the Chinese yuan, the South Korean won, and the Taiwanese dollar. The latter can reflect the dollar’s real position in global trade more accurately and aligns better with today’s market conditions.

For investors, understanding changes in the U.S. dollar index is truly important. Whether you’re trading foreign exchange, investing in gold, or simply trying to figure out whether the Taiwanese dollar will appreciate or depreciate, the U.S. dollar index is a basic skill you must pay attention to. It’s like a weather vane for where global capital flows—by watching its fluctuations, you can better anticipate changes in asset values and where the risks may be.