What Is the Forex Market?
The foreign exchange market is where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can’t pay in euros to see the pyramids because it’s not the locally accepted currency. As such, the tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.
One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over-the-counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney—across almost every time zone. This means that when the trading day in the U.S. ends, the forex market begins anew in Tokyo and Hong Kong. As such, the forex market can be extremely active any time of the day, with price quotes changing constantly.
A Brief History of Forex
Unlike stock markets, which can trace their roots back centuries, the forex market as we understand it today is a truly new market. Of course, in its most basic sense—that of people converting one currency to another for financial advantage—forex has been around since nations began minting currencies. But the modern forex markets are a modern invention. After the accord at Bretton Woods in 1971, more major currencies were allowed to float freely against one another. The values of individual currencies vary, which has given rise to the need for foreign exchange services and trading.
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s were exchanged for other goods. The system then evolved and goods like salt and spices became popular mediums of exchange. Ships would sail to barter for these goods in the first ever form of foreign exchange. Eventually, as early as 6th century BC, the first gold coins were produced, and they acted as a currency because they had the critical characteristics like portability, durability, divisibility, uniformity, limited supply and acceptability.
Gold coins became widely accepted as a medium of exchange, but they were impractical because they were heavy. In the 1800s countries adopted the gold standard. The gold standard guaranteed that the government would redeem any amount of paper money for its value in gold. This worked fine until World War I where European countries had to suspend the gold standard to print more money to pay for the war.
The foreign exchange market was backed by the gold standard at this point and during the early 1900s. Countries traded with each other because they could convert the currencies they received into gold. The gold standard, however, could not hold up during the world wars.
KEY EVENTS WHICH HAVE SHAPED THE FOREX MARKET
Throughout history, we have seen major events that have greatly influenced the forex trading environment. Here are some highlights:
The Bretton Woods System 1944 – 1971
The first major transformation of the foreign exchange market, the Bretton Woods System, occurred toward the end of World War II. The United States, Great Britain, and France met at the United Nations Monetary and Financial Conference in Bretton Woods, NH to design a new global economic order. The location was chosen because at the time, the US was the only country unscathed by war. Most of the major European countries were in shambles. In fact, WWII vaulted the US dollar from a failed currency after the stock market crash of 1929 to benchmark currency by which most other international currencies were compared.
The Bretton Woods Accord was established to create a stable environment by which global economies could restore themselves. It attempted this by creating an adjustable pegged foreign exchange market. An adjustable pegged exchange rate is an exchange rate policy whereby a currency is fixed to another currency. In this case, foreign countries would ‘fix’ their exchange rate to the US Dollar. The US dollar was being pegged to gold, because the US held the most gold reserves in the world at that time. So foreign countries would transact in the US Dollar (this is also how the US dollar became the world’s reserve currency).
The Bretton Woods agreement eventually failed to peg gold to the US dollar because there was not enough gold to back the amount of US Dollars in circulation, because the amount of US Dollars in circulation increased due to increased government lending and spending. In 1971, President Richard M. Nixon, ended the Bretton Woods system which soon led to the free floating of the US Dollar against other foreign currencies.