The origin of Forex trading traces its history to centuries ago. The need for different currencies and their exchange had existed since the Babylonians. Speculation did not happen in those days. The value of goods was expressed in terms of other goods also called as Barter System. The main disadvantage of such a system was that it was not an accepted mediums of exchange. It was important that a common base of value could be established. Soon various metals particularly gold and silver, established themselves as an accepted means of payment and a store of value.
The first coins were used at the times of the pharos and the first paper notes were introduced by the Babylonians.
Before the First World War, most Central banks supported their currencies with convertibility to gold. However, the gold exchange standard had its weaknesses. It would require to import a great deal from out of the country until it ran down its gold reserves needed to support its money.
The Bretton Woods System (1944-1973) began after the instability of World War II. Many European countries were left in ruins after the war ended. On the other hand the US's economy was left stable and strong. The Great Depression and the removal of the gold standard in 1931 created a serious drop in Forex market activity. From 1931 until 1973, the Forex market went through many changes which in turn affected the global economies at the time. Speculation in the Forex markets during these times was little. The Bretton Woods agreement resulted in a system of fixed exchange rates.
After WWII, the USD became the prominent currency mainly because of the war. The Dollar also became the new global reserve currency, and still remains. After the Bretton Woods agreement ended, Free Floating exchange rates came into use. The European Economic Community introduced a new system of fixed foreign exchange rates in 1979, the European Monetary System. London was, and still remains the principal offshore market. In the 1980s, it became an important center in the Eurodollar market. In Asia, currency after currency was devalued against the US dollar, resulting in other fixed exchange rates looking very vulnerable.
In 1994, the first online currency trading was introduced to Forex history. This had a great impact on the development of the Euro currency. By 2002 the Euro became the official currency for 12 European nations, and in the past few years more nations have joined this agreement. Because of the frequent and rising use of Internet technology, modern online forex trading has offered new options for the online trader.
In the beginning, the Forex market worked under the central banks and the governmental institutions but later on it joined hands with various other institutions including commercial banks, corporations, brokerage houses and individual investors. The size of the Forex market is now greater than any other investment market. It is the largest financial market in the world. Approximately 1.9 trillion dollars are traded daily in the foreign exchange market. The Forex market has now emerged as a lucrative opportunity for the modern day investor.
So, What is Forex Trading ?
Forex Trading refers to the trading of currencies from different countries against each other. Forex is the short form of Foreign Exchange. Foreign exchange is the currency of any country anywhere in the world, such as the US Dollar, the Chinese Yuan, and the British Pound etc. The concept of forex trading is that one currency is exchanged for another. This is called currency trading.
For example, the currency in circulation in Europe is Euro (EUR) and in the United States the currency is the US Dollar (USD). You will buy the Euro and simultaneously sell the US Dollar. The Foreign Exchange is the largest exchange market in the world. It operated round the clock Sunday to Friday, and it is a 24 hour market. It does not close daily like the stock market. Furthermore, it is an international market, so it is bigger than any domestic stock market. Speculators on the forex market make money depending on the currency movements of the market and develop their own forex trading strategy. The most commonly traded currencies are the US Dollar, the Euro, the British Pound, and the Japanese Yen. With the recent boom of Internet technology and the prospects of quick, hefty profits, FOREX trading has grown in popularity among different investors.
Forex trading is usually done through a broker. Orders can be placed with just a few clicks and the broker then passes the order along to a partner in the Interbank market to fill your position. When you close your trade, the broker closes the position on the Interbank Market and credits your account with the loss or gain. This can happen within just a few seconds.
As a trader you will choose a pair of currencies that you expect to change in value. Then you will place a trade accordingly. Hypothetically, if you had purchased 1,000 Euros in January, and it would have cost you around $1,200 USD. Throughout the year the Euros value vs. the U.S. Dollar’s value increased. At the end of the year let’s say 1,000 Euros was worth $1,300 U.S. Dollars. Now if you end your trade at this point, you would have a $100 gain.
Foreign Currency trading systems- Short position and Long position: You can take a position on a country, depending on what you believe are the future prospects for that country and then either buy or sell its currency. For example, if you believe that the US dollar will fall in value or depreciate against the Euro, you would sell US dollars now at a higher price with the expectation of buying them from the market at a lower price when the US dollar depreciates. You will make the differential payment between the higher price and the lower price per dollar that you sold. Since you did not actually have possession of US dollars at the time you sold them, it is called a short position.
The opposite of this is a long position. This means that you believe the US dollar will rise in value or appreciate and you buy US dollars with the expectation of selling them at a higher price when the market for them goes up. This is long trade or long position.
The Forex Market And Its Three Distinctive Elements
Distinctive elements are those elements that every new trader should know before they make their first trade. The first step to being a successful trader is knowing how the system of forex trading works. Before you open a Forex account, make yourself familiar with the foreign exchange market’s three distinctive aspects which are: geographical, functional, and participant.
Geographical Element
The Forex market is a huge and global market. It is spread all the way from North America to Europe, to the Far East, and back. The reasons for its growing popularity are numerous. It has access to all areas of the world. It is an easy and round the clock market with 24 hours a day accessibility. You can trade at any time of the day since there will be someone trading in some distant location around the world. The main foreign exchanges are in New York, Tokyo, Sydney, Singapore, Hong Kong, Bahrain, London and San Francisco. The geographical element of the foreign exchange market is useful for new traders to assess the size and volume of the Forex market. It has large and unmatched volume making it a powerful and profitable tool for investment.
Functional Element
The Forex market has the job to transfer purchasing power between countries. When trades are undertaken, partners convert their currency incomes into their domestic currency. If one country’s purchasing power is strong, the other country will have weak purchasing power. The Forex market helps to obtain and provide credit for international trade. The Forex is helpful in this regard because it assists in the movement of goods between countries and offers credit facilities too for financing.
Participant Element
The two main components which constitute the foreign exchange market are the Interbank, or the wholesale market and the client or the retail market. Further subdivision of these two categories results in five different types of participants.
The first type of participant is the bank and non-bank foreign exchange dealers. They buy at bid prices and sell at asking prices.
The second type of participants are individuals, commercial and investment firms including importers, exporters, tourists, and other portfolio investors. They use the market to help them invest.
The third group type includes the speculators and arbitragers. They are people who want to make money for themselves. They act in their own self-interest. Large banks are sometimes a part of this group.
Central Banks and treasuries are also another type of participants. Their motive is not to profit but to influence the market. They want the value of the domestic currency to benefit their interests.
The fifth and last type consists of Foreign exchange brokers. They facilitate trading but are not partners in the transaction. They usually charge a fee for the service rendered.
source folsol.com