The History of Forex Trading

If you’ve ever exchanged your country’s currency for that of another country while traveling, you’ve done a basic kind of foreign exchange or forex trading.

On a larger scale, forex trading involves buying and selling currency through a global network. Much like stock traders, forex traders try to determine which currencies will rise in value. They purchase those currencies while selling other currencies whose value may drop.

The similarity to stock trading might make forex trading sound like a modern invention, but it actually has its roots in ancient times. Here’s a quick guide to the history of forex and where it is today.

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What Is Forex Trading?

Forex trading involves trading national currencies as what are known as exchange-rate pairs. Each type of currency has a ticker symbol, much like stocks do. For example, the U.S. dollar’s symbol is USD, and the euro’s symbol is EUR. 

With an exchange-rate pair, you trade one currency against the other. So if you want to trade the euro against the U.S. dollar, you’d use the currency pair EUR/USD.

There are a couple of ways you can make money trading forex. One way is to profit from changes in the exchange rate. 

If you know anything about exchange rates, you know that the value difference between two currencies is typically small. To generate meaningful profit, you need to use what’s known as leverage, which is borrowing money so you can purchase a larger lot size, multiplying potential profits and losses.

You also can profit from the interest rate differential between currencies, in which you pocket the difference between the interest earned by both currencies.

There are a few different ways to trade currency. These are the three main submarkets within the forex market:

• Futures market: You enter into a contract to buy or sell a specific currency amount at a specific time in the future.
• Forward market: You enter into a private contract with another trader to exchange currency at a set rate in the future.
• Spot market: You buy or sell currency in real-time as the exchange rate fluctuates.

So what exactly makes the exchange rate fluctuate? It comes down to supply and demand. Over time, certain currencies become more in demand, either to pay for goods and services or to be held as investments.

Understanding the History of Forex Trading

Compared to some other types of investments, forex trading has an interesting history. It dates back to ancient times, and it has evolved substantially since then.

Where Forex Trading Began

The earliest form of forex trading was the barter system used in Mesopotamia as early as 6000 B.C. But the first real forex market was created in Amsterdam in the 17th century. It exchanged Dutch and English currency.

Investment banks in the U.S. and Europe also began their own forex trading operations. But the first major change was the adoption of the gold standard. With this standard, more convenient paper money was put into general circulation. Governments promised that any amount of paper currency could be exchanged for its value in gold. 

The next major development was the 1944 Bretton Woods agreement between Canada, the U.S., Australia, Japan and several countries in Western Europe. It stipulated that currencies would fluctuate only 1% up or down from the par exchange rate.

Key Events that Shaped the Foreign Exchange Market

In more recent times, three key events have further shaped forex trading. During the 1973 oil crisis, President Nixon broke up the Bretton Woods system, doing away with fixed exchange rates.

The adoption of the euro in 1999 as a major currency also shaped the market. Twelve European countries adopted the euro, and EUR/USD is still the most commonly traded currency pair.

The global financial crisis of 2008 also impacted the history of forex. Bank failures, most notably that of Lehman Brothers, made forex more volatile than ever and widened the bid-ask spread, which meant that asking prices began to dramatically exceed bid prices.

Where Forex Is Today

With a daily trade volume of over $5 trillion, forex is booming. Electronic trading has made buying and selling dramatically easier, and online trading platforms have made forex more accessible for individuals. Algorithmic trading has also simplified the trading process, and as much as 75% of trading activity is assisted by algorithms.

Key Players in Forex Trading

The stock market has a centralized headquarters in the New York Stock Exchange. The forex trading network, on the other hand, involves a web of traders, banks, hedge funds and regulatory bodies. Here are the key players you need to know about:

• Central banks: These banks set the price of their respective currencies on the market,
• Commercial and investment banks: The largest volume of trades on the forex market comes from banks of all sizes,
• Multinational corporations: These companies primarily trade currencies to pay for goods and services,
• Hedge funds and investment managers: These traders are responsible for the second-largest volume of trades after banks,
• Individual investors: Retail investors and other individual investors make up a smaller portion of the market, but their representation is growing quickly,
• Regulatory bodies: There is no central regulating body for forex trading; instead, different countries and regions have their own regulating organizations.

For traders, understanding the rules and regulations set by regulatory bodies is of critical importance. When you understand the rules, you minimize your risk of accidentally committing fraud — or falling victim to it.

What Makes the Forex Market So Attractive to Investors?

You might wonder why so many investors branch out from the stock market to discover the frontier of forex trading. The truth is that forex trading offers a number of enticing advantages.

• It’s traded 24 hours per day, five days per week, so you have more time each day to cover your losses and make profits.
• There’s plenty of available leverage that can lead to multiplying profits.
• It requires a much lower starting investment than trading stocks.
• Because it’s a decentralized market, forex trading is much harder for outside entities to manipulate (for instance, it’s much harder to obtain and use insider information).

Bear in mind that the potential for multiplied returns also has a downside — it opens up the potential for multiplied losses as well. Forex traders, especially new traders, would be wise to put careful thought into their trading decisions.

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The possibility of high returns and great liquidity might draw you into the dynamic world of forex trading. However, before getting involved, being mindful of the potential risks is critically important.

If you’re eager to tackle the steep learning curve and willing to start by working with an investment adviser, forex trading can be enlightening, profitable and enjoyable. Benzinga is proud to offer resources to help you succeed.

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