Table of Contents
Chapter 1: What is Forex Trading
Chapter 2: History of Money and Origins of Forex Trading
Chapter 3: Forex Trading Terminology
Chapter 4: Important Aspects of Forex Trading
Chapter 5: Players in The Forex Market
Chapter 6: Factors that Affect the Forex Market
Chapter 7: Risks Involved With Trading Forex
Chapter 8: Why Trade in the Forex Market
Chapter 9: How Forex Trading Works
Chapter 10: How to be a Successful Forex Trader
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History of Money and Origins of Forex Trading
– Why Barter Failed
– Precious Metals
– Paper as a Means of Payment
– Government IOUs
– Gold Standard
– Bretton Woods Agreement 1944
– Foreign Exchange Concept
Chapter 2: Money and Origins of Forex Trading
In order to better understand the forex market, it is important to trace how currencies and their market came into being and what factors led to their creation. The need for trade has been in existence ever since man came to live as a civilized being. The first trading systems were based on barter. Goods were exchanged for other goods.
The major shortcoming of this system was that it was too difficult to maintain. The seller had no way of knowing if he will find the goods he needed in exchange for his. A buyer interested in his goods may not have anything of interest for the seller. With perishable goods or immovable ones, the problems were even worse. These issues brought about a need for a standard payment method which could be used at any time by anyone and would be accepted widely as a representative of value. The first currency was born.
Initially, people used precious metals as currency. Coins and ingots were used to buy and sell goods. This system was the precursor of the gold reserve which later came to back currencies because it set a value on the metal which could be used to conduct trade. This value was later represented by paper currency.
But it was difficult to carry and safeguard precious metals when traders traveled to far flung markets. This led to the creation of a more compact and easy to carry payment method – paper.
Since the time of the ancient Babylonians, people have traded goods and services in exchange for paper currency in some form or the other. Receipts were also used extensively to represent ownership of goods in many parts of the world. These receipts would be passed on or traded in exchange for other goods. This system required the establishment of centralized storage places which were regulated and organized by parties that were not interested in the trade itself.
Government IOUs
Following these receipts in lieu of goods, governments started issuing IOUs to the public during the Middle Ages. Although many unstable governments failed to make good on their IOUs, the system caught on where there was stability in the political leadership.
Even after the use of paper currency became more prevalent, the use of precious metals, especially gold was still considered the cornerstone of commerce. This faith in gold values permeated into currency so that banks valued paper currency in terms of the gold reserve which backed it. This was the gold standard. Under this system, all currency could be exchanged to an equivalent amount of gold.
Shortcomings of the Gold Standard
As economies and the population grew, and with them the volume of trade, it often became necessary to issue fresh paper currency to cover all transactions. The volume of paper currency in the economies across the world grew to such an extent that all paper money could no longer be backed by gold. In other words, if a person wished to convert his paper money to an equivalent amount of gold, he wouldn’t be able to any longer.
This led to much uncertainty among the public. There was another issue that hurt the concept of using the gold standard – foreign trade was affected badly by it. High level of exports would increase gold reserves in the country leading to more issuance of paper currency, while more imports would have the opposite effect.
After World War II, the Bretton Woods agreement introduced a worldwide system of currency with its basis being the US dollar. The dollar would be represented with a gold value and other world currencies would link their values to the dollar. The underlying standard was still gold in an indirect manner in this system.
As world economies started to expand, the cracks in this system began to show in spite of many stop gap adjustments and realignments. The abolishment of the gold standard by Nixon finally ended the Bretton Woods system.
Even after the Bretton Woods system was no longer in use, the concept of comparing currencies against each other held fast and was the precursor to foreign exchange trade as we know it today. The European Economic Community brought in fixed exchange rates with the European Monetary System in the late 1970s. Although this was not very successful, the quest for easy exchange of currency persisted.
Floating exchange rates soon came to be used instead of linking the currency to gold or dollars. This is the system predominantly in use today, with market forces determining the value of a currency. Some countries, especially those with weaker economies, adopt other currencies or link theirs to a globally accepted one, if they want to avoid the floating rate system.
The US adopts a floating rate policy for its currency wherein the dollar value is determined by the supply and demand for it. Its price is in constant movement when compared with other currencies and this creates a great opportunity for investors to make money.
To begin with, the Forex market was heavily controlled by large financial institutions and central banks of major economies. Activities by these institutions could change the direction of whole economies. In fact, central banks often used forex transactions to achieve specific economic goals and facilitate foreign trade. This is still true to a large extent of forex markets activities by these institutions and governments.
Over time, the forex market has emerged as a market place for individual investors too. These investors are usually only interested in making profits from the price fluctuations. Despite begin highly speculative and volatile, forex still continues to be the most traded market in the world.
Next Chapter: Forex Trading Terminology