Forex Trading Guide

What is FOREX? Introduction and History of Foreign Exchange

Introduction

The great crash of 1929

What is FOREX? We will talk about the history and introduction of the FOREX Market. FOREX, the Foreign Exchange market was established in 1971 when floating exchange rates began to materialize.

Unlike currency futures and the stock market, the FOREX market is not centralized. Trading orders (transactions) are performed mainly over computers and telephones throughout the world.

FOREX trading involves banks, investors and speculators exchanging one currency to another. The major and most traded currencies are US Dollar (USD) and the Euro (EUR). Great British Pound (GBP), Japanese Yen (JPY), and the Swiss Franc (CHF).

FOREX: The biggest market in the world

Compared to other markets such as the stock market, FOREX is by far the largest financial market in the world. The Foreign Exchange market is open 24 hours a day 5 days a week. Except for new year holidays where it is closed for a short period of time.

The market opens on Monday morning in Sydney Australia, followed by Tokyo Japan, London England, and New York United States.

It wasn’t always easy to become a FOREX trader

Getting involved in and trading on the FOREX market was not always an easy thing for individual traders. Once upon a time, professional traders from major commercial and investment banks were the dominant force in the FOREX market.

Big corporations, global money managers, registered dealers. International money brokers, futures and options traders, and private speculators are the other FOREX participants.

FOREX for everybody

It is good to know that in modern days anybody can trade FOREX. All you need is a computer (or simply just a smartphone or tablet), internet connection. And an account with a FOREX broker.

Why do people trade FOREX? The main reasons to participate in the FOREX market are the ability to facilitate an actual transaction and earn money. Whereby international corporations convert earned profits in foreign currencies into their domestic currency.

The Corporates and Money Managers

Corporate treasurers and money managers are also involved in the FOREX market. The reason for this is to hedge against unwanted exposure to future price movements in the FOREX market. Another reason is speculation for profit.

An attractive factor about trading FOREX is investors can respond to currency fluctuations. Caused by economic, social and political events at the time they occur whether it’s day or night. FOREX is a volatile market in which traders can make or lose money on a daily basis.

Money, in one form or another, has been used by people for thousands of years by various civilizations. At first it was mainly Gold or Silver which eventually evolved to coins.

The Merchandise was traded against other goods or against gold. As time moved on the price of gold became a reference point.

When the trading frequency of products increased between nations, moving quantities of gold around places. Settling payments of trade became complicated and difficult. Not to mention risky and time-consuming.

A system in need

Therefore, a system was required. By which the payment of trades could be settled in the seller’s local currency throughout the world.

The question now is how much of buyer’s local currency should be equal to the seller’s local currency?

The answer was simple. The strength of a country’s currency depended on the number of gold reserves the country maintained.

Therefore, if the country “A’s” gold reserves are double the gold reserves of country “B”. Country A’s currency will be twice in value when exchanged with the currency of country B.

The Gold Standard

This happened to become and to be known as The Gold Standard. Here and there around the year 1880, The Gold Standard was agreed, accepted and used worldwide.

War, FOREX, and Money

In the time of World War 1, in order to fulfill the enormous financing requirements. Paper money notes were created in quantities that far exceeded the gold reserves.

The currencies lost their standard parities and caused a gross distortion. In the country’s standing in terms of its foreign liabilities and assets.

After the end of World War 2, the western allied powers attempted to solve the problem. At the Bretton Woods Conference in New Hampshire in 1944.

The Gathering

Within the first few weeks of July 1944. Representatives from 45 nations gathered at the United Nations Monetary and Financial Conference. In Bretton Woods, New Hampshire.

At the meeting, representatives discussed issues such as the postwar recovery of Europe as well as various monetary concerns. Things such as unstable exchange rates and protectionist trade policies.

A majority of the world’s major economies had unstable currency exchange rates throughout the 1930s. Additionally, many nations had restrictive trade policies in effect.

The British Proposal

During the early 1940s, the United States and Great Britain developed proposals for the creation of new international financial institutions. With the aim to stabilize exchange rates and boost international trade.

Also, a recognized need to organize a recovery of Europe was required. In the hopes of avoiding the problems that arose after World War 1.

Representatives at Bretton Woods reached an agreement known as the Bretton Woods Agreement. In order to establish a postwar international monetary system of convertible currencies with fixed exchange rates and free trade.

Economic Aid for Europe

The agreement created two international institutions to facilitate these objectives. The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank).

The intention was to provide economic aid for the reconstruction of postwar Europe. The World Bank’s first act was an initial loan of $250 million to France in 1947.

Due to the Bretton Woods Exchange System. The currencies of involved nations could be converted into the US dollar at a fixed rate. In addition, foreign central banks could convert the US dollar into gold at a fixed rate.

US Dollar: The New Dominant Currency

In other words, the US dollar replaced the then dominant British Pound. And the parties of the world’s leading currencies were pegged against the US Dollar.

Another factor of The Bretton Woods Agreement is that it was also aimed at preventing currency competition. Including promoting monetary co-operation among nations.

In accordance with the Bretton Woods System, the IMF member countries concurred to a new system of exchange rates. A new system which could be adjusted.

Within defined parities with the US dollar or with the agreement of the IMF. Changed to correct a fundamental lack of stability in the balance of payments.

The US Retaliation

The per value system remained in use from 1946 until the early 1970s. The United States, under the leadership of President Nixon, retaliated in 1971.

This was done by devaluing the dollar and forcing a realignment of currencies with the dollar.

Europe, by aligning their currencies in a narrow band and then float collectively against the US dollar. The leading European economies attempted to counter the United States’ move.

The good thing is, this currency war did not last long and by the mid-1970s. The leading world economies scrapped the fixed exchange rate system for good and floated their currencies in the open market.

The idea was to let the market decide the value of a given currency based on demand and supply. Including the currency and the economic health of the currency’s nation.

This market is well known as the International Monetary Market or IMM.

The IMM is not a single entity. It is rather a group of all financial institutions having a worldwide interest in foreign currencies. Banks, Brokerages, Fund Managers, Government Central Banks and sometimes individuals as an example.

This went on to be the present system of exchange of foreign currency markets. Although the currency’s value is dependent on the market impacts. Central banks still continue trying to keep currencies in a preset fluctuation range.

This is done by taking one or more of the various steps. The ITO (International Trade Organization) that had been planned in the Bretton Woods Agreement. Was unable to be realized in the form initially forecast. Because the US Congress refused to endorse it.

However and Instead. It was later created in 1947. In the shape and form of the General Agreement on Tariffs and Trade. The agreement was signed by the United States, Canada, and 23 other countries.

The GATT later became known as the World Trade Organization. In recent years the two international institutions. The World Bank, and the IMF. All faced a major challenge in helping debtor nations getting back on their stable financial paths.

The Euro-market

A major boost to increasing of FOREX trading was the fast development of the Eurodollar market. In which US dollars are deposited and distributed across banks outside the US. Likewise, in Euromarkets assets are deposited outside of Europe.

The Eurodollar market was first established in the 1950s. At a time when Russia’s oil revenue (all in dollars) was deposited outside the US.

It came amidst fear of being frozen by US regulators. Giving rise to a vast offshore pool of dollars outside the control of the United States’ authorities.

Laws to restrict dollar lending to foreigners were forced by the US government. Euromarkets were appealing due to fewer regulations. While offering higher yields. From the late 1980s onwards, US companies started borrowing offshore.

Discovering Euromarkets a beneficial center for holding excess liquidity. Providing short-term loans. Along with financing imports and exports.

London was and remains the principal offshore market. In the 1980s, becoming the key center in the Eurodollar market. British banks began lending dollars as an alternative to Great British Pounds.

This ensured England to maintain its leading position in global finance.

The convenient location of London is also an additional factor in holding its dominance in the Euromarket.

Important Dates in FOREX History

Early 20th Century

In the 20th-century paper money notes began regular circulation. This happened by force of legislation with efforts of central banks to manage money supplies. Along with government control of Gold supplies.


Within a country, this fiat money is as worthy as any other form. However, internationally it is not.

International trade always demanded a money standard to be accepted everywhere.

This standard was already provided by Gold and Silver for centuries. In which the Gold Standard regulated the value of money for about a century. Before World War 1 began in 1914.

1929

The dollar has been perceived as mostly obsolete. Because of the big Stock Market Crash in October 1929. Leading to the subsequent Great Depression throughout the 1930s.

1930

The BIS (Bank for International Settlements) (BIS) founded in Switzerland. With the purpose of overseeing the financial efforts of the newly independent countries. Also to providing monetary help to countries with financial difficulties.

1931

The Great Depression along with the suspension of the Gold Standard. Caused a critical decrease in foreign exchange dealings.

World War 2

Before World War 2, currencies around the world were quoted against the Great British Pound. World War 2 crashed the Pound.

The United States was the only country financially unharmed by the war. The US dollar became a respected, dominant currency throughout the world.

1944

During the United National Monetary and Financial Conference at Bretton Woods, New Hampshire. Discussions took place regarding the financial future of the post-war world.

The major Western Industrialized nations agreed to fix (limit) the US Dollar at $35.00 to the troy ounce of gold.

The future was designed with a focus on stability. Partially due to the tight governmental controls on currency values. The US dollar also became the world’s Reserve Currency.

1957

The European Economic Community was established.

1967

Rio de Janeiro 1967. At the IMF meeting in Special Drawing Rights (SDRs) were established. Special Drawing Rights are international reserve assets. Developed and established by the IMF. In order to supplement the existing reserve assets.

1971

The Smithsonian Agreement was reached in Washington, D.C.. in 1971. The agreement had a transitional role in the free-floating markets.

The ranges of currencies fluctuations relative to the US dollar. An increased from 1 percent to 4.5 percent was applied. The range of currencies fluctuating against each other increased up to 9 percent.

Laterally, the European Economic Community tried to move away from the US dollar block. Toward the Deutsche Mark block by creating its own European Monetary System.

American President Nixon removed the United States off the Gold standard in 1971. Shortly after floating exchange rates began to form.

1972

Belgium, France, Italy, Luxembourg. Along with the Netherlands and West Germany, Developed the European Joint Float.

Member currencies were allowed to fluctuate within 2.25 percent band (the snake), against each other and 4.5 percent band (the tunnel) against the USD.

1973

In 1973 under severe market pressures. The Smithsonian Institution Agreement and the European Joint Float systems fell apart. Following the second major devaluation of the US dollar.

The US Government completely scrapped the fixed-rate mechanism. It was then replaced by The Floating Rate.

1978

The International Monetary Fund formally ordered free currency floating.

1979

The European Monetary System was established.

1999

The Euro made its official appearance. Within the countries members of the European Union on January 1, 1999.

2002

On January 1st, 2002. The Euro becomes the only currency and replaces all other12 national currencies. Within the European Union and Monetary Market:

Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy. Luxembourg, Netherlands, Portugal, and Spain.