The principle that lies behind the idea of the Forex market started with when metals such as gold and silver started being minted into coins. People would use the value of these metals in coin form to pay for things. When this time in monetary history started is when we can say that the Foreign Exchange Market, too, started.
Wherever gold was accepted as an international currency, key marketplaces would be established at strategic points around the world. These points of trade would house massive ports that supported large cargo ships carrying all sorts of valuable goods and commodities. They would then trade these items for the gold or silver coins.
Over time, countries started bringing their own currencies with the option to convert those currencies back to gold. Though there were some who exchanged paper money for gold, back in those times it was a rarity. This lack of gold conversion caused an abundant supply of paper money, which ultimately led to crazy inflation, which led to political instability.
Something had to be done.
The Bretton Woods Agreement of 1944
Image credit: Wikimedia under CC license
It wouldn’t be until 1944 that a globalised solution would be formed. World War II was approaching what seemed to be an end. It the war’s wake, the world was thrown into all sorts of chaos and economic instability. Major global economies of the time decided it would be best to give value to all global currencies through the value of gold. Gold was then valued in terms of the United States Dollar. This was called the Bretton Woods Agreement.
People thought the Bretton Woods system would be the end-all solution to the problem, but it only ended up causing bigger problems. A global demand for the dollar abruptly grew, but the world’s gold supply just couldn’t keep up with the global demand for the United States Dollar. Increased demand for the USD was necessary to maintain liquidity for world economic growth and trade, but with gold shortages, the USD didn’t have the support it needed.
Now what had been meant to be a solution became a huge problem for the global economy. The Bretton Woods Agreement was a failure.
The Beginning of the Floating Exchange Rates
The United States Dollar was no longer able to hold the pegged rate to gold at $35 an ounce. It was in 1971 that President Nixon put an end to the Bretton Woods Agreement. This transformed the Foreign Exchange into a free-floating currency system. There were some who wanted to bring different forms of the Bretton Woods Agreement back, but they were all shot down.
The market was now able to decide the value of each currency through supply and demand thanks to the floating exchange rates. Who decides this? Essentially it is the “stay at home forex trader” who affects the value of global currencies through his or her trading activities.
One individual’s action can barely be felt – if at all. But the entire bulk of Forex traders as a collective, buying and selling currencies, determine a free-floating currency’s value at any given time. This allows savvy traders to “capitalise” on the fluctuating rates by entering a Forex trade a just the right moment. It is kind of reminiscent of a surfer waiting to catch that perfect wave. The flip side is, if traders jump in too soon or too late, they can lose – sometimes, losing big.
The Electronic Communications Network Changed the Game
There was a time when the free-floating currency market was primarily traded by large commercial companies, hedge funds and banks. This usually meant that people with money only had an opportunity to trade Forex. Thanks to technological advances, the expansion of the internet and the Electronic Communications Network (ECN), “electronic trading” began slowly opening the doors for average people to join the market.
The ECN created a decentralised environment, allowing people to conduct trades outside of an exchange. This opened the floodgates as investors all over the globe were able to trade no matter their location or time zone.
The ECN also made it possible for brokers to appear as market makers. They placed themselves as the gateway to Forex trading, setting their own Bid and Ask prices along the way – this is how they make a profit. Brokers will act on the behalf of their clients, placing trades on the ECN network at an increased price than what they actually bought the currency for – now they are profiting from each trade order placed with them.
This gave birth to the retail Forex traders you see today – people like you and me. All we have to do is sign up with a broker on some Forex site and now we too are connected to the ECN network. We download some charting software, download some app on our smartphones and start placing trades within minutes.
So, you see? We have come a long way. Technology is only making it easier as time goes by. It is not hard at all to join the Forex trading community, often times only costing as little as $100 to start Forex trading.
