Forex Market History

Prior to 1971, the Bretton Woods Agreement prevented speculation in the currency markets. The Bretton Woods Agreement was set up in 1945 with the aim of stabilizing international currencies and preventing money fleeing across nations. This agreement fixed all national currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold. Prior to this agreement, the gold exchange standard had been used since 1876. The gold standard used gold to back each currency and thus prevented kings and rulers from arbitrarily debasing money and triggering inflation. Institutions like the Federal Reserve System of the United States have this kind of power.

However, the gold exchange standard had its own problems. Inevitably, economy’s gold reserves would be run down due to imported good from overseas. As a consequence, the country’s money supply would shrink resulting in interest rates rising and a slowing of economic activity to the extent that a recession would occur.

Eventually, the recession would cause prices of goods to fall so low that they appeared attractive to other nations. This in turn led to an inflow of gold back into the economy and an increase in money supply which led to the fall of interest rates and the strengthening of economy. These boom-bust patterns prevailed throughout the world during the gold exchange standard years until the outbreak of World War I, which interrupted the free flow of trade and thus the movement of gold.

After the war, the Bretton Woods Agreement was established, where participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar. A rate was also used to value the dollar in relation to gold. Countries were prohibited from devaluing their currency to improve their trade position by more than 10%. Following World War II, international trade expanded rapidly due to post-war construction and this resulted in massive movements of capital. This destabilized the foreign exchange rates that had been set-up by the Bretton Woods Agreement.

The agreement was finally abandoned in 1971, and the US dollar was no longer convertible to gold. By 1973, currencies of the major industrialized nations were floating more freely, controlled mainly by the forces of supply and demand. Prices were set, with volumes, speed and price volatility, all increasing during the 1970s. This led to new financial instruments, market deregulation, and open trade. It also led to a rise in the power of speculators.

In the 1980s, the movement of money across borders accelerated with the advent of computers and the market became a continuum, trading through the Asian, European and American time zones. Large banks created dealing rooms where hundreds of millions of dollars, pounds, euros and yen were exchanged in a matter of minutes. Today, electronic brokers trade daily in the Forex market. In London for example, single trades for tens of millions of dollars are priced in seconds. The market has changed dramatically with most international financial transactions being carried out not to buy and sell goods, but to speculate on the market, with the aim of most dealers to make money out of money.

London has grown to become the world’s leading international financial centre. It is the world’s largest Forex market. This arose not only due to its location, operating during the Asian and American markets, but also due to the creation of the Eurodollar market. The Eurodollar market was created during the 1950s when Russia's oil revenue, all in US dollars, was deposited outside the US in fear of being frozen by US authorities. This created a large quantity of US dollars that were outside the control of the US. These vast cash reserves were very attractive to foreign investors as they had far less regulations and offered higher yields.

Today, London continues to grow as more and more American and European banks come to the city to establish their regional headquarters. The sizes dealt with in these markets are huge. The smaller banks, commercial hedgers and private investors hardly ever have direct access to this liquid and competitive market, either because they fail to meet credit criteria, or because their transaction sizes are too small. However today, market makers are allowed to break down the large inter-bank units and offer small traders the opportunity to buy or sell any number of these smaller units (lots).

History of Retail Forex

As a whole, retail trading is more structured than the Forex market. While Forex has been traded since the beginning of financial markets, modern retail trading has only been around since about 1996. Prior to this time, retail investors were limited in their options for entering the Forex market. They could create multiple bank accounts, each one denominated in a different currency, and transfer funds from one account to another in order to profit from fluctuating exchange rates; this was troublesome. The transaction costs incurred were large due to the small quantity of funds being converted relative to the size of the market. This transaction type was at the very bottom of the Forex pyramid.

By 1996, new market makers took advantage of developments in web-based technology that made retail Forex trading practical. The new companies felt that there was enough liquidity in the Forex market, and eventually within their own customer base, to guarantee markets under all but the most unusual market conditions. These companies also created online trading platforms that provided a quick and easy way for individuals to buy and sell on the Forex Spot market. In addition, the companies realized that by pooling many retail traders together, they had the size to enter the upper echelons of the Forex market, which reduced the size of the spread. As the business grew, the market makers were given better prices, which they then passed on to the customer.

Central Banks

A Central Bank will intervene to buy or sell currencies if they believe it is substantially under or overvalued and that it is having a negative effect on the economy. The national central banks play a key role in the foreign exchange markets as many central banks have very substantial foreign exchange reserves, thus their intervention power is significant.

Commercial Banks

Banks are licensed deposit-taking institutions; they also support a variety of other services including foreign exchange. These banks will trade currencies among themselves as part of the system of balancing accounts. While exchange rates for their largest customers are extremely competitive, small and medium sized enterprises and individuals will typically pay a large premium when transacting foreign exchange with their local branch. The interbank market caters for both the majority of commercial turnover as well as enormous amounts of speculative trading every day. It is not uncommon for a large bank to trade billions of dollars on a daily basis.

Non Banking Corporations

The Non Banking Corporations group is comprised of companies who are involved in the 'goods' market, conducting international transactions for the purchase or sale of merchandise. Exporters are made up of a diverse range of companies exporting goods and services. Generally, exporters have a positive impact on the value of a country's currency. Importers use the foreign exchange markets to purchase foreign currency to make payments for the goods and services they have bought in other countries. They generally have a negative impact on the value of a country's currency. Their trade sizes are mostly inconsequential to affect immediate moves in the market, given the large volume traded daily on the Forex market. However, since a major key factor for long term trend of currency movements is the balance of trade, if taken as a whole, the capital flows arising from these corporations end up having a significant impact.

Hedge Funds

Hedge Funds influence has increased significantly in the last few years, thanks to the overall growth in their industry and abundance of funds at their disposal; however, the net effect of this group depends on the investment decisions they make. With the growth of the FX industry they have been, wherever possible, investing heavily in foreign securities and other foreign financial instruments.

Brokers

Brokers can be classified into Interbank and Client brokers, with the influence of the former declining in the last few years due o the shift of businesses to electronic trading systems. The advent of online pricing systems has revolutionized the operational capabilities of this market and changed the traditional role of brokers. But even in the past, most banks were unable to service the needs of small to medium sized organizations as well as commercial and private clients, with large corporations as their main targeted market. Thus, keeping in mind the client’s needs to invest a certain amount of minimum margin and still have the ability to be able to trade on competitive spreads, led to the advent of Online Broking Companies - FXGM belongs to this group.

Investors/Speculators

Given that the Forex market has high liquidity, a large amount of leverage and the 24/7 operational nature of the market, it has been an attractive playing field for speculators. The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs.