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Business : Forex History
The forex exchange today boasts a global nature. For that reason, it’s crucial that one examines important historical events regarding currencies and currency exchange even before making entry into any trades. This section will serve to review the international monetary system, taking a look at how it has evolved to the current state. We’ll look at major players occupying the forex market- quite an essential factor requiring proper comprehension by all potential forex traders.
Forex History
1. Gold Standard System
Creation of the gold standard system (1875) marked one of the most crucial historical events of the forex market. Before the implementation of this system, countries commonly used gold and silver as international payment means. However, the value of these payment systems was affected by both external supply and demand. Case in point, any discovery of a new gold mine would imply gold prices being driven down.
Governments were able to convert currency into specific amounts of gold and vice versa using the gold standard system. As such, gold would back a currency. Governments obviously needed a fairly substantial gold reserve so as to meet the demand for exchanges of currencies. By the late 19th century, all major economic countries had clearly defined a currency amount to an ounce of gold.
As time progressed, the difference in the price of a gold ounce between two different currencies was considered as the exchange rate for those currencies. This was the first standardized currency exchange means in history.
Eventually, this system broke down when World War I began. The political tension in Germany caused major European powers to feel the need to have large military projects completed. These projects created a greatly substantial financial burden such that there wasn’t enough gold by then to exchange for all excess currency printed off by the governments.
The gold standard did make a small comeback, only to be dropped again by most countries when World War II began. Gold however, never ceased to be the ultimate monetary value form.
2. Bretton Woods System
Before the World War II ended, the Allied nations had felt the need to set up an enhanced monetary system that’d fill the void left behind by the abandonment of the gold standard. In July 1944, over 700 representatives from the Allies had a convention at Bretton Woods in New Hampshire. They deliberated over what’d be referred to as the Bretton Woods system.
Bretton Woods led:
- A strategy being formed for fixed exchange rates
- The gold standard being replaced by the U.S. Dollar as the primary reserve currency
3. Three international agencies being created to oversee economic activity
The U.S. Dollar then became the only currency backed by gold. This was the primary reason for the eventual failing of Bretton Woods. Richard Nixon, a former U.S. President, closed the gold window, announcing to the world that the U.S. would no longer facilitate for exchange of gold for the U.S. dollars which were held in foreign reserves.
Current Exchange Rates
The world had to finally accept using floating foreign exchange rates in the Jamaica agreement (1976). This implied permanent abolishment of the gold standard. That isn’t to say that governments adopted a purely free-floating exchange rate system. Governments make use of one of three exchange rate systems which are still in use today:
1. Dollarization
This occurs in case a certain country makes the decision not to issue their own currency, thus adopting a foreign currency as their national currency. The drawback with this system is that that country’s central bank won’t print money any longer, or even define any kind of monetary policy.
2. Pegged Rates
Pegging will occur once a country decides to fix its exchange rate directly to a foreign currency. The country will thus have some more stability than the normal float. The country’s currency will be exchanged at a fixed rate against a single or specific basket of foreign currencies. That currency will only fluctuate in the event where the currencies pegged change.
3. Managed Floating Rates
This system is created when a certain currency’s exchange rate is allowed to change freely in value, subject to market forces of demand and supply. In this case however, the central bank or government can intervene so as to stabilize any extreme fluctuation in the exchange rates.
For instance, a country’s currency may depreciate far beyond what would be considered an acceptable level. The government may act by raising short-term interest rates. This should cause slight appreciation of the currency. That is quite a simplified example. Typically, central banks will consider employing several tools to manage their currency.
Forex Trading
The most unique aspect of the forex market would be that it doesn’t have any central marketplace for foreign exchange. Most regular stocks tend to trade on well defined markets such as the New York Stock Exchange. All transactions in the world occur happen through computer networks between traders as currency trading is conducted electronically over-the-counter.
There’re three ways through which corporations, institutions and individuals trade forex, namely the spot, forwards, and futures markets. The latter two are based on the spot market, making the spot market the largest.
1. The Spot Market
Simply put, this sees the purchase and sale of currencies, in accordance with the current price. This price is determined by demand and supply. That price is a reflection of numerous factors, including the current interest rates being offered on loans, the economic performance of countries, ongoing political situation, as well as the perception of a currency’s future performance compared to another. A spot deal’ is a completed deal. Trades in this market usually take two days for actual settlement.
2. Forwards and Futures Markets
These simply do as suggested by their names, for delivery in future. These contracts enable one to lock in a currency type, a price per unit, and a date in future for settlement.
Contracts in the forwards market are bought and sold over-the-counter between two parties who’ve already determined the terms of agreements.
Future contracts in the futures markets are bought and sold on a certain exchange, and are usually based on a standard size and the delivery date. In the U.S., the futures market is regulated by the National Futures Association. Such contracts have specific details which can’t be customized: the number of units, minimum price increments, and settlement and delivery dates.
Playing Part
In practice, speculators can play part in these markets. The forwards and futures markets may reduce the risk during the exchange of currencies. It’s important to pay close attention to the news, as this will enable you to analyze actions of central banks. Any changes in monetary policies would ultimately imply changes in currency exchange rates.
Forex Volumes
For a specific currency to be traded, and for its price to go from a level to another, volume will be required. Volume is essential for a market to move. By knowing how institutional money operates, we’re able to track traders and thus trade along with them.
The study of volume, with price, began in the early 1900s with Richard Wyckoff, a forex trader. His research developed into what’s referred today to as Volume Spread Analysis (VSA). Not all VSA techniques or traders are similar. Some are software-driven, complex, and others are simple. When kept simple, VSA is applicable more easily and more probable to win higher rates.
Innovation in Forex Trading
In the recent years, innovative developments in web-related technologies have allowed for formation of internet-based trading platforms by independent brokers. These brokers then serve as the market-makers, providing a 2-way quote for each pair they support.