The modern forex market is the world’s largest and most liquid financial market, trading trillions of dollars every day. Thanks to the rise of instant funding prop firms, it’s now possible for anyone to take part in forex trading with little personal financial risk and the potential for high rewards. But how did this financial phenomenon come into existence?
The roots can be traced back to 1944 and the negotiation of the Bretton Woods Agreement, named for the small New Hampshire location where the conference of international economists and politicians was held.
Here’s a look at how this landmark event reshaped the world’s financial system and birthed the modern forex market.
The backdrop of the Bretton Woods conference
In July 1944, the global economy was staggering from the impact of two World Wars (World War II would not reach its conclusion until September 1945), and there was a pressing need to develop a unified global trading framework.
Under the pre-1944 system, currencies fluctuated wildly and international trade was plagued by uncertainties and inequalities between nations. This obviously did not create ideal conditions for the world economy to rebuild after the devastating impact of the wars.
Before the outbreak of World War I in 1914, most countries followed the Gold Standard, which involved fixing the value of their currencies to a specified amount of gold, or pegging their currency to a country that did so. This created stability and allowed countries to trade internationally amid a system of checks and balances.
However, after the outbreak of World War I, the gold standard was largely abandoned because it was too inflexible and countries needed unprecedented access to funds for the war effort. The interwar years saw a period of instability as currencies were rapidly devalued and the previous balance of payments was thrown out of kilter.
This resulted in the Great Depression, and world leaders were keen to avoid similar mistakes after the conclusion of WWII. This clarified the need for a new financial system that was both stable but also afforded the flexibility to enable global trade to flourish and foster long-term growth, without descending into currency wars.
Enter the Bretton Woods Agreement
The Bretton Woods summit in summer 1944 lasted for three weeks, but in fact the preparations had been going on in the background for several years. One of the principal architects of the agreement was the English economist John Maynard Keynes, who is considered to be one of the most influential economists of the 20th century.
The conference president was U.S. Treasury Secretary Henry Morgenthau Jr., and 730 delegates from 44 allied nations across the globe attended the summit to make active contributions and sign the agreement. The new system was designed to be more flexible than the Gold Standard, but less unpredictable than the unstructured interwar years.
The key elements included:
Fixed exchange rates: The creation of a fair and efficient foreign exchange system was set up by a requirement for participating nations to peg their currencies to the US dollar, which in turn was pegged to the price of gold.
Currency stability: Participating countries would commit to maintaining their exchange rate within a narrow margin either side of the fixed rate. If the currency fluctuated too much, the central bank would step in with corrective measures.
International oversight: Two new financial institutions were established to help manage the new system: the International Monetary Fund (IMF) and the World Bank.
Why was the US dollar used to underpin the system?
The US dollar was selected as the default global currency because at the time the US economy was the world’s biggest, and the least damage had been inflicted on its industrial base. The US also held the majority of the world’s gold reserves.
How does the forex market tie in?
The exchange of foreign currencies was still necessary to maintain fixed rates in the wake of Bretton Woods, although there wasn’t the scope for frequent trading and profit making that there is today. The early forex markets were tightly controlled, and access was limited to central banks and large financial institutions.
The collapse of the Bretton Woods system
By the 1960s, weakness in the Bretton Woods system began to be exposed. The US gold supply was dwindling as state spending increased, and the strength of the dollar was called into question. In 1971, the US President Richard M. Nixon devalued the US dollar and suspended its convertibility into gold, and the system collapsed entirely by 1973.
The rise of the the modern forex market
The abandonment of the Bretton Woods system left countries free to choose their own exchange mechanisms. Some chose to link the value to another country’s currency, but others chose to let the currency float freely on the market, so the value was determined by supply and demand.
This system formed the basis of the modern forex market and the resulting volatility opened the floodgates for investors and speculators. However, during the 1970s through to the early 1990s, forex trading was mostly limited to city bankers and multinational corporations.
Traders relied on phones and telex machines to carry out transactions, and this limited the scope to carry out real time trades. Governments and central banks still operated strict currency controls in most cases, so the market was much less dynamic than it is today.
All this changed with the rise of the internet and digital technology in the 1990s and 2000s. Digital trading platforms could be accessed by solo traders from a laptop anywhere in the world round the clock, and prop firms offered the opportunity to trade with funded accounts, eliminating the element of personal financial risk.
The government controls of the forex markets were relaxed, and today it is a decentralised and highly liquid market that is largely unregulated. While this brings risks, it also offers the potential for skilled traders to make consistent profits. The vast majority of trades are now carried out for speculative purposes, rather than as a result of international trade or travel.
How to get started with forex trading
If you’ve read this far, then you are probably intrigued about how to get involved with forex trading yourself. Taking some time to learn about the history of the forex markets is a great first step, because you already have an understanding of how it has evolved from a closed shop to an open global marketplace.
You will also have grasped the advantages and drawbacks of such a system. Free-floating prices that are driven by supply and demand mean that currency prices can fluctuate dramatically according to political events or economic data releases, and the 24/7 decentralised markets mean that you are not tied to fixed trading windows.
However, this volatility also means that the forex markets can be difficult to predict and complex for new traders to navigate. As well as a sound understanding of what drives market movements, you will also need to be able to use technical analysis tools such as charts, graphs and moving averages.
Ways to learn online
There is plenty of free material out there to help you learn the basics of forex trading, but you’ll have to put some legwork into sifting the wheat from the chaff. Steer clear of courses or YouTube gurus who claim that you can make millions of dollars within a few months, because unless you’ve already got a finance background this is highly unlikely.
Pick a course that doesn’t make any unrealistic promises, and is transparent about the risks as well as the rewards of forex trading. Once you have a grasp of basic trading terminology such as pip, spread, leverage, and margin size, put together a structured trading plan. Keep it simple: there will be plenty of time to fine tune it later on.
One of the most crucial aspects of successful forex trading is strong risk management skills. Always use stop loss orders to protect yourself from making steep losses, and make sure that you understand your risk tolerance levels.
Put your skills to the test
After a certain point, the best course of action is to put your theoretical knowledge to practical use. You can use a demo account to practice trading in simulated market conditions, but the lack of real pressure might hold back your progress.
One of the most popular ways to access forex trading with low personal financial risk is to sign up for a 14 day free trial with a prop firm. This means that you will have access to a virtual funded account and real time market conditions.
You’ll gain experience of using a world-leading trading platform, and you’ll have the added motivation of profit targets to hit and risk management rules to operate within. If you prove you’ve got what it takes, you can progress to the evaluation stage and on to a fully funded account with profit share.