The History of Foreign Exchange is Recent by Most Any Standard
The history of foreign exchange, or the “forex” market as it is commonly called, is as old as money itself. As soon as the first businessman or traveler crossed a national border, the issue of having money that would work in the local market became a true concern. Governments and central banks eventually established the ground rules for making cross-border conversions to settle these commercial transactions, but the current forex market, where over $4 trillion is transacted daily, is more a recent phenomenon than a holdover from the distant past.
Retail online forex trading has come of age in only the past ten years. Before the millennium crossover, currency trading was primarily the “playground” for the world’s largest banks. Transaction lot sizes were $1 million, and average transactions were for $5 million and up. Even wealthy individuals had a tough time cracking into this market, but technology and creative forex brokers found a way to aggregate trades and offer smaller lot sizes, thus opening the way for one of the fastest growing and popular investment activities today.
The forex market is the largest and most liquid market in the world. Except for a few organized exchanges for options and futures trading, market activity is primarily decentralized on a global basis. The world’s largest global banks, supported by a secure electronic communication system, constitute what is called the “Interbank Market”, where over 50% of daily volume consists of moving money back and forth between these banks. Forex brokers contract with these banks to provide access for other market participants, including individual retail forex traders.
Today’s market of floating exchange rates, however, is an outgrowth of the seventies. Following World War II, government officials were concerned that a global rebuilding effort could not succeed if exchange rates were allowed to fluctuate freely. The Bretton Woods Agreement “pegged” major currencies to the U.S. Dollar, the greenback was set at $35 per ounce of Gold, and central banks maintained strict daily variation limits of one percent versus the Dollar “peg”. The artificial rate setting process served its purpose, providing stability when it was needed most, but President Nixon in 1971 made the Gold Standard a thing of the past, substituting our nation’s guarantee as acceptable backing for our currency.
For the balance of the decade, many regional exchanges sprung up to handle local cross-border commerce independent of U.S. Dollar influences, and by 1978, all major currencies were officially “floating” in this new global marketplace. Globalization led to enormous growth and variation in forex derivatives, primarily supporting international commerce, but increasingly tending toward a market where speculation reigned supreme. The level of volatility in the market amazed finance officials at first. Speculation thrives on volatility, the only reason that trading exists in the first place, but speculation actually creates more efficient pricing behavior and leads to tighter quote spreads, both viewed as necessary benefits.
Sophisticated trading software produced programs that could analyze and assimilate mountains of pricing data, resulting in real time charts with technical indicators to facilitate the trading process. Coupled with Internet access, retail forex traders can now access the market from their cell phones while sipping a latte at the nearest Starbucks. The heaviest traded currency pair, the “EUR USD”, can now provide traders with opportunities most all business days.
Guest contribution provided by Forex Traders.