Prior to testing your knowledge and luck in the online trading forex it would be interesting to know a few things about the history, the initial inception and the subsequent development of the currency or forex market. Let us take you on a short journey highlighting the milestones that made the forex world what it is today:
The History of the Forex Market
Up until at least the early 1970’s trading for investment purposes or speculative trading, i.e. achieving profit on the fluctuation in the prices of currencies and other investment securities, was a rare occurrence and for most common folk trading was focused on commodities and the stocks of companies.
Currency trading at this time was almost exclusive carried out for the facilitation of international commerce, that is to cater to the needs of big companies conducting business transactions in many countries.
The currency market was largely governed by provisions of the Bretton-Woods Accord of 1944, which was an agreement covering several international policies with the aim of alleviating and minimizing the economic chaos that most of the countries were faced with at the time of the conclusion of World War II. The Bretton Woods provision with the greatest effect on the world economy was the decision to peg or link all other foreign currencies to the U.S. dollar which was itself pegged to the price of gold. In practice, this decision made the value of the other currencies directly dependent on the value of the dollar, while the value of the dollar was in turn tied to the value of gold, back then standing at $35 an ounce.
Fixing the value of a currency to a specific quantity of gold, known as Gold Standard Currency, in essence means that the holder of the country’s currency can convert funds to an equal amount of gold. This was the case with the USA under the Bretton Woods Accord provisions, obligating the US government to be maintaining gold reserves equal to the amount of US dollars in circulation.
Before seeing how the forex market evolved out of this situation, please bear in mind that the opposite of the gold standard currency arrangement is the fiat or floating currency system, wherein it is the forces of demand and supply in the market which determine the rise or fall in the value of a currency. It is this fluctuation that makes it possible to speculate on future currency values and which consequently allows a forex market to exist.
What led to the evolution of an Open Forex Market was the decision in 1971, of American President Richard Nixon, who decided to address the various problems that arose through the provisions of the Bretton Woods Accords, by eliminating the gold standard for the U.S. dollar. This was mainly done in order to combat the rising gold prices which were contributing to high inflation levels for the US economy. The birth of the modern, over the counter currency market was the result of this action which had led to free-floating currency exchange rates.
This was a very welcome change because the Bretton Woods provisions, by its linking of other currencies to the dollar was making the US currency the de facto world currency and made it impossible for sovereign nations to manage the value of their own currency.
Likewise, the US was unhappy that the value of the dollar itself was subject to fluctuations in the price of gold, because when gold prices rose this also send the dollar upwards and resulted into a severe inflation crisis in the US.
The end of the Bretton Woods Agreement and the emergence of free-floating currencies and thus the modern currency market, was in fact the result of two separate events. The first was the creation of what came to be known as the Eurodollar market, Eurodollars being U.S. funds held in banks outside the regulatory control of the U.S. government. This happened primarily because of the oil market. In post WWII period, the Soviet Union was a very important oil producer and it was receiving huge amounts of US dollars as its international selling contracts were settled in dollars. At a time when the “Cold War” between the east and west was culminating, USSR was worried that the US could attempt to seize their bank accounts containing huge amounts of dollars and thus decided to deposit them in European banks, where they would be out of the reach of American authorities. This created the Eurodollar market, which soon grew to become an important source of lending capital for governments and large companies around the world.
The second development that ended the Bretton Woods Agreement was a simultaneous inflation and energy crisis in the US, which had meant the erosion of the dollar’s purchasing power and a sharp increase in the price of oil and other commodities, pushing investors to resort to buying gold in order to protect their savings.
As a result, gold prices soared and due to the pegging so did the value of the US dollar, thus further exacerbating the inflationary pressures. To put an end to this double crisis and primarily to the inflation in the US economy President Nixon dropped the gold standard requirement and devalued the U.S. dollar to 1/35th of an ounce of gold, thus making it possible for a foreign exchange market to evolve.
Today’s forex market: Interbank and OTC Trading
The primary playing field where forex trading occurs is through an established interbank market. Only large financial institutions, i.e large banks are able to deal directly in this market, mostly because non-bank outsiders are forced to pay high service fees to trade in this market. The trading done in this framework of the foreign exchange market is known as institutional forex trading.
A forex transaction is in all instances a deal between two contracting parties and it is not conducted in a physical location, such as a stock exchange, since it is primarily an “over-the-counter” (OTC) market.
Exchange-Based Trading however is also possible, especially after the Chicago Mercantile Exchange (CME) became the first exchange to offer currency trading, when in 1971 it launched the International Monetary Market (IMM).
Web-Based Forex Trading
In recent years, aided largely by new developments in web-related technologies, a large secondary currency market has evolved. This resulted in the creation of an extensive network of online brokers offering direct currency trading services through online trading platforms, in what has come to be known as the retail forex sector. These brokers serve as market-makers providing a two-way quote, (i.e. a bid and ask price) for which the dealer agrees to buy or sell a particular currency, for each currency pair they support. Forex dealers are referred to as market-makers since by offering both sides of a trade, they literally “make” a market for those wishing to engage in currency trading.