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about forex market
The foreign exchange (currency or forex or FX) market exists wherever one
currency is traded for another. It is by far the largest market in the world, in
terms of cash value traded, and includes trading between large banks, central
banks, currency speculators, multinational corporations, governments, and other
financial markets and institutions. The trade happening in the forex markets
across the globe currently exceeds $1.9 trillion/day (on average). Retail
traders (small speculators) are a small part of this market. They may only
participate indirectly through brokers or banks.
History
The forex market is a cash inter-bank or inter-dealer market, which was
established in 1971 when floating exchange rates began to appear. The foreign
exchange market is huge in comparison to other markets. For example, the average
daily trading volume of US Treasury Bonds is $300 billion and the US stock
market has an average daily volume of less than $10 billion. Ten years ago the
Wall Street Journal estimated the daily trading volume in the forex market to be
in excess of $1 trillion. Today that figure has grown to exceed $1.8 trillion a
day.
Prior to 1971 an agreement called the Bretton Woods Agreement prevented
speculation in the currency markets. The Bretton Woods Agreement was set up in
1944 with the aim of stabilising international currencies and preventing money
fleeing across nations. This agreement fixed all national currencies against the
dollar and set the dollar at a rate of $35 per ounce of gold. Prior to this
agreement the gold exchange standard had been used since 1876. The gold standard
used gold to back each currency and thus prevented kings and rulers from
arbitrarily debasing money and triggering inflation.
The gold exchange standard had its own problems however. As an economy grew it
would import goods from overseas until it ran its gold reserves down. As a
result the country’s money supply would shrink resulting in interest rates
rising and a slowing of economic activity to the extent that a recession would
occur.
Eventually the recession would cause prices of goods to fall so low that they
appeared attractive to other nations. This in turn led to an inflow of gold back
into the economy and the resulting increase in money supply saw interest rates
fall and the economy strengthen. These boom-bust patterns prevailed throughout
the world during the gold exchange standard years until the outbreak of World
War I which interrupted the free flow of trade and thus the movement of gold.
After the war the Bretton Woods Agreement was established, where participating
countries agreed to try and maintain the value of their currency with a narrow
margin against the dollar. A rate was also used to value the dollar in relation
to gold. Countries were prohibited from devaluing their currency to improve
their trade position by more than 10%. Following World War II international
trade expanded rapidly due to post-war construction and this resulted in massive
movements of capital. This de-stabilised the foreign exchange rates that had
been set-up by the Bretton Woods Agreement.
The agreement was finally abandoned in 1971, and the US dollar was no longer
convertible to gold. By 1973, currencies of the major industrialised nations
became more freely floating, controlled mainly by the forces of supply and
demand. Prices were set, with volumes, speed and price volatility all increasing
during the 1970’s. This led to new financial instruments, market deregulation
and open trade. It also led to a rise in the power of speculators.
In the 1980’s the movement of money across borders accelerated with the advent
of computers and the market became a continuum, trading through the Asian,
European and American time zones. Large banks created dealing rooms where
hundreds of millions of dollars, pounds, euros and yen were exchanged in a
matter on minutes. Today electronic brokers trade daily in the forex market, in
London for example, single trades for tens of millions of dollars are priced in
seconds. The market has changed dramatically with most international financial
transactions being carried out not to buy and sell goods but to speculate on the
market with the aim of most dealers to make money out of money.
London has grown to become the world’s leading international financial centre
and is the world’s largest forex market. This arose not only due to its
location, operating during the Asian and American markets, but also due to the
creation of the Eurodollar market. The Eurodollar market was created during the
1950’s when Russia’s oil revenue, all in US dollars, was deposited outside the
US in fear of being frozen by US authorities. This created a large pool of US
dollars that were outside the control of the US. These vast cash reserves were
very attractive to foreign investors as they had far less regulations and
offered higher yields.
Today London continues to grow as more and more American and European banks come
to the city to establish their regional headquarters. The sizes dealt with in
these markets are huge and the smaller banks, commercial hedgers and private
investors hardly ever have direct access to this liquid and competitive market,
either because they fail to meet credit criteria or because their transaction
sizes are too small. But today market makers are allowed to break down the large
inter-bank units and offer small traders the opportunity to buy or sell any
number of these smaller units (lots).
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