What comes to mind when you hear the term Foreign Exchange or Forex? Maybe pictures of traders facing several screens or real-time flashing USD/EUR currency pairs. Forex is the biggest and most liquid financial market in the world, and it plays a significant part in the global economy. It is much more than just numbers and charts, though.
What is trading in foreign exchange?
The term “foreign exchange,” or “forex trading,” describes the international market where currencies are purchased, sold, and traded. It works in major financial centres like London, New York, Tokyo, and Sydney, and it is open twenty-four hours a day, five days a week.
An International Currency Exchange
Predicting whether one currency will grow or decrease against another is the fundamental task of forex trading. For instance, you would purchase the USD/EUR currency pair if you think the US dollar will appreciate vs the euro. You can benefit from the shift in exchange rates if you’re right.
Pairs of currencies
Currency pairs used in forex trading are classified as follows:
– Major Pairs: Include the USD and are the most traded (e.g., EUR/USD, GBP/USD)
– Minor Pairs: Don’t include the USD but involve major currencies (e.g., EUR/GBP, AUD/JPY).
– Exotic Pairs: One major currency paired with an emerging market currency (e.g., USD/TRY).
The History of Forex Trading
Although the idea of exchanging currencies is not new, the current Forex market as we know it is relatively new. Let’s examine its development:
1. Barter System and Early Currency Use
- Before money, people used barter systems — trading goods and services directly. The introduction of coins (by the Lydians around 600 BC) marked the beginning of currency-based trade.
- As civilizations grew, coins and eventually paper money became common. Still, there was no unified system for exchanging one currency for another.
2. Gold Standard Era (1870s–1914)
- The Gold Standard was introduced to provide stability in international currency exchange. Each country’s currency was backed by a fixed amount of gold, enabling predictable exchange rates.
- While it provided structure, it also limited economic flexibility — especially during crises like World War I, which led to its eventual decline.
3. The Bretton Woods Agreement (1944–1971)
- After World War II, world leaders established a new financial order via the Bretton Woods Agreement. The system pegged major currencies to the US dollar, which was convertible to gold at $35 per ounce.
- This agreement aimed to prevent the chaotic currency devaluations that led to the Great Depression. However, it began to unravel in the late 1960s due to US trade deficits and gold shortages.
- In 1971, President Richard Nixon officially ended the gold standard, leading to floating exchange rates — the foundation of today’s Forex market.
4. Birth of the Modern Forex Market (1970s–1990s)
- With the end of Bretton Woods, currencies began floating freely. Banks, corporations, and governments needed to exchange currencies for trade and investment. This created a growing need for an efficient currency exchange system.
- In the 1990s, the internet revolution allowed retail traders — individual investors — to access Forex trading platforms. This democratized access to a previously elite financial sector.
5. The Rise of Online Forex Trading (2000s–Present)
- Today, Forex is powered by technology. Anyone with a computer or smartphone and internet connection can trade Forex via online brokers.
- Advancements in tools like TradingView, MetaTrader 4/5, and real-time news analytics have made Forex trading more accessible and data-driven than ever.