The Factors That Shaped Modern Forex Trading
Modern forex trading is now one of the most popular and exciting methods of financial trading in the world, thanks to a liquid market which is easily accessible to anyone with an internet connection and a forex funded account. This is a relatively modern development of course, but the history of forex trading has deep roots.
The concept of forex trading—that is, exchanging foreign currencies—can be traced back for centuries. The current market is shaped by significant events from the past, and it is useful for any forex trader to understand how these occurred, because history tends to repeat itself. Here’s a look at how it all began.
The early bartering system
It could be argued that modern forex trading began when prehistoric cave dwellers began to exchange animal skins for meat or flint tools. In fact, some societies in the world still use the bartering of goods and services as a means for survival, in place of money. However, using currency makes the whole process faster and (usually) fairer.
The first coins and notes
The world’s oldest known coins have been discovered in Guanzhuang in Henan Province, China, according to Investopedia. Archaeologists from the State University of Zhengzhou have dated the coins back to 640 BC. Records of the use of metal coins can also be found in the works of Greek poets from the 6th century BC.
It is thought that the Romans were the first to establish a centralised system for minting money, which was operated by the government. This is not so different from the centralised banking systems which still dominate today.
It is thought that the first system of using paper notes instead of money was introduced during the 7th century BC in China. This was probably a result of the inconvenience of tradesmen having to undertake long journeys weighed down by bags of heavy metal coins.
Apparently, early Chinese banknotes were printed with the blunt warning: “Those who are counterfeiting will be beheaded.” Of course, counterfeit bank notes are still a serious problem today, although the penalties are not usually quite so barbarous. By the Middle Ages, lower value coins made from copper rather than silver or gold were minted.
It took until the 16th century for paper money to become widely used throughout Europe and North America. This opened the gateway to increased international trade, as the whole process became quicker and more fluid.
It also led to the beginnings of the first foreign exchange market, as banks and governments were able to buy currencies from other nations.
The Gold Standard
The next major development in the history of financial trading was the adoption of the gold standard. This was a guarantee that a government would redeem an amount of paper money for its value in gold. By pegging a currency’s value to gold, this created a system where an economic unit was based on a fixed quantity of gold.
Gold has been considered a precious metal since the earliest ages, because of its unique qualities of strength, malleability, density, and limited resources. It has always been used as a decorative metal and to made sacred artefacts, and it was used to make coins from about 700 BC onwards.
The gold rushes and pillages in the New World in the 15th and 16th centuries intensified the gold trade wars, until eventually the Gold Standard was introduced as the basis for the international monetary system during the 1870s. In the US, a united national currency pegged to the value of silver and gold had already been in operation for almost a century.
However, England was the first country to officially adopt the Gold Standard in 1821. The international Gold Standard was consequently adopted by all the major economies by the beginning of the 20th century. This system flourished until the outbreak of WWI in 1914, when European countries became mired in war debt.
The supply of gold could no longer keep up with the growth of the global economy, and the use of the Gold Standard became unsustainable. Smaller nations began holding the US dollar and the Great British Pound as their reserve currencies instead of gold, thus reducing its fluidity even further.
To this day, the US dollar is the world’s biggest reserve currency, and represents the least exchange risk. This is why beginner forex traders, as well as many experienced ones, almost always include the US dollar as one of their currency pairs.
Even those traders who avoid the USD still keep a close eye on its movements in the market, because what is affecting the value of the USD has a ripple effect on the direction of the whole forex market.
The Bretton Woods Agreement
The next major development occurred in 1944, with the historic Bretton Woods Agreement. This refers to the outcome of the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, which was held in 1944.
The conference was attended by delegates from 44 countries, with the aim of agreeing a workable foreign exchange system to promote global economic growth. The International Monetary Fund (IMF) and the World Bank, still two major global financial institutions today, were also created at the meeting, outlasting the agreement itself.
The key principles of the Bretton Woods Agreement had already been carefully prepared by the British economist John Maynard Keynes and the US Chief Economist, Harry Dexter White. The basic operating principle of the system pegged the US dollar to the price of gold, and all other currencies within the system were pegged to the value of the USD.
The idea behind the Bretton Woods Agreement was to help create a stable international currency exchange rate, which would facilitate more frequent and profitable international trade, and promote good trading relationships between countries. This worked well for a time, but by the early 1970s, the US gold supply had become depleted.
The Bretton Woods Agreement was abolished in 1973, because it was no longer adequate to support rapidly growing economies. However, the IMF and the World Bank still play an important role in supporting the development and functioning of the world’s emerging economies.
Today, the forex markets are mostly comprised of free-floating currencies which are subject to the pressures of supply and demand. However, central banks still have a means of influencing the forex markets, through the control of interest rates.
That’s why it’s important for forex traders to follow the economic news, especially for any data releases involving interest rate rises or falls in the major economies. Rising US interest rates will have an influence throughout the entire forex market, because it will affect the value of the dollar, which is the most widely traded currency in the world.
The Plaza Accord
By the 1980s, it was recognised that the strength of the dollar in relation to other currencies was stifling the economic growth of other nations. Therefore, the G5 group of the world’s leading economies, including Great Britain, France, West Germany, Japan, and the US, agreed to deliberately appreciate other currencies against the dollar.
This agreement was reached at a meeting at the Plaza Hotel in New York, and was therefore known as the Plaza Accord. The result was much greater fluctuation in the forex markets, which made for ideal trading conditions for the sharp-eyed forex trader, because the potential to make big profits was created by sharp upturns and downturns in price.
The creation of the Euro
The next significant event was the agreement between European Union nations in 1992, known as the Maastricht Treaty, to establish a major new currency. This led to the birth of the Euro in 1999, with 11 member EU countries adopting it as their currency. It has since grown to be one of the world’s major currencies, used by 19 EU countries.
The advance of the internet
The next major advancement of forex trading was brought about by the internet. Until the 1990s, only large banks and other financial institutions could access the forex markets, but the advance of the world wide web changed all this.
Information which once involved a series of international phone calls and a whole team of traders could now be retrieved in seconds by a simple internet search engine query.
At the same time, the globalisation of the world economy began to flourish as the Berlin wall came down and the Soviet Union dissolved. This led to a huge expansion in forex trading, as individuals as well as banks and merchants entered the markets.
Today, anyone can open a forex trading account through an online broker, even if they have only a modest amount of capital to invest. High leverage means that there is potential for skilled traders to make good and consistent profits, and some individuals even make forex trading their full-time career.
More than $5 trillion are traded every day on the forex markets, with endless opportunities for the well-informed trader to make profits. It does take commitment and hard work, but learning to trade forex is certainly an exciting and potentially very lucrative venture.