Introduction to Currency Trading
Forex is a market in which participants are allowed to buy, sell, exchange and speculate on currencies. The markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and investors. Currently, the Forex market is considered to be the largest financial market in the world with the equivalent of over $3.2 trillion daily turnover; more than three times the total amount of the US Equity and Treasury markets combined. The trading volume has increased rapidly especially after exchange rates were allowed to float freely in 1971.
Besides, Forex are believed to be the most efficient financial markets because the currency markets are large and liquid and it is constructed of a global network of computers that connects participants from all around the world.
Therefore, many currency speculators rely on the availability of enormous leverage to increase the value of potential movements. In the retail forex market, leverage can be as much as 250:1. Higher leverage can be extremely risky, but because of round-the-clock trading and deep liquidity, foreign exchange brokers have been able to make high leverage an industry standard in order to make the movements meaningful for currency traders.
The forex market provides plenty of opportunity for investors. However, in order to be successful, a currency trader has to understand the basics behind currency movements.
The goal of this forex tutorial is to provide a foundation for investors or traders who are new to the foreign currency markets. We'll cover the basics of exchange rates, the market's history and the key concepts you need to understand in order to be able to participate in this market. We'll also venture into how to start trading foreign currencies and the different types of strategies that can be employed.
How Does Forex Market Work?
Long ago, the world's economy was based on the bartering system in which the value of a particular item was measured by its worth in exchange for other items. However, this system had apparent restrictions. There was no way of obtaining items needed if had nothing valuable to be exchanged. This created the need to establish a more adequate way of buying and selling early in history. In various cultures and economies, anything could be considered valuable as long as there was a need for it. Eventually, precious metals such as gold and silver had become the monetary standard.
The current online Forex history begins in 1973. Even though currency trading has been around since the era of ancient Egypt, which at that time the market was extremely prehistoric, and there were no advance trading tools. The first currency coins were used at the era of the Pharos, and the first paper notes were then introduced by the Babylonians. Soon after, the roman coin called aureus was used, which was followed by the denarius. Both coins had been used worldwide, making them the first global foreign currency coins.
Before the beginning of World War I, the “gold standard” has been employed to allow a national currency to be exchanged only for gold in order to prevent governments from arbitrary emission, which accelerates inflation, but this standard unable to solve all problems. Very few people took advantage of this practice because many often felt it was unnecessary for the government to stock a full reserve of gold in their central banks.
A country's growing economy led to the import boost to a point where gold resources were depleted. Thus, the amount of money in circulation decreased resulting in interest rates grew and economic activity slowed down to the stage of recession.
After World War II, great instability arises. England and other European countries were left in ruins, after the war ended, while the US’s economy was left relatively stable and strong. The Dollar also became the new global reserve currency, and remained so throughout the rest of the Forex history. The Bretton Woods agreement was then existed under which exchange rates of national currencies were fixed to the dollar and the dollar itself was pegged to gold with the price per ounce set equal to 35 dollars. Participating countries agreed to maintain the value of their currency with a narrow margin against the dollar and a corresponding rate of gold as needed. Currencies devaluing to countries’ trade advantage were prohibited and were only allowed to do so for devaluations of less than 10%. A new international financial network was formed.
Yet, post-war reconstruction of the global economy and the increase in trade between the countries demanded a reconsideration of the fixed rate, and in 1971 the agreement was temporarily suspended. The US Dollar is no longer convertible into gold.
By 1973, currencies of major industrialized nations floated more freely. Currencies were controlled mainly by the supply and demand forces. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, giving rise to new financial instruments, market deregulation and trade liberalization. In 1994, the first online currency trading was seen introduced in Forex history. For simplicity, the process of Forex evolution can be view in flowchart.