A Brief History of Forex Trading

A Brief History of Forex Trading

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Foreign exchange trading, or commonly known just as forex or FX trading, is the act of exchanging fiat currencies. The process involved with forex trading in currency markets is thought to be centuries old, dating back to the Babylonian period.

Today, the forex market is one of the largest, most liquid, and accessible financial markets in the world, and it has been shaped by several important global events such as Bretton Woods and the gold, to only name one.

When trading in the foreign exchange market, all forex traders need to understand the history of forex trading and the key historical events that have shaped the market.

Who Started Forex Trading?

The Mesopotamia tribes introduced forex trading in 6000BC with the barter system.

This barter system involved one tribe exchanging goods that another tribe needed to obtain goods that they needed.

 

How was Forex Founded?

The barber system evolved, and goods such as salt and spices became popular mediums of exchange. First, however, foreign exchange evolved as follows:

  • 6BC – Gold coins were produced, and they acted as currency in foreign exchange.
  • In the 1800s – Gold coins became impractical due to their weight, and the gold standard was adopted. The Gold standard guaranteed that governments would redeem any amount of paper money for its value in gold.
  • World War I – European countries suspended the gold standard to print more paper money to fund the war. During this period, the foreign exchange market was backed by the gold standard.
  • The early 1900s – Countries started trading with one another to convert the currencies they received into gold.
  • 1933 – The gold standard was removed, and the forex market was born.
  • 1944 – Through the initiative of the United States of America, the new world's currency was initiated, and the United States Dollar, or USD, was used.
  • 1947 – IMF started operating, and the US Dollar served as the price of gold, fixed at $35 per ounce.
  • World War II and onwards – the US Dollar became the prominent currency.
  • 1971 – the Smithsonian Agreement was signed by ten of the major financial powers.
  • 1973 – Reuters replaced telephones and telex, which was used for trading quotes, with computer monitors.
  • 1990 – The first online currency trading was introduced.

 

When did Online Forex Start?

During the early 1990s, in 1994, the currency markets had grown to become sophisticated and faster than ever. Again, this is a result of changes in money and the way that people view it. 

During the 1990s, there was the widespread adoption of the internet, and banks and small companies created online networks. These networks produced automated quotes and allowed for instantaneous trading of currency pairs around the world.

There was a free-floating currency market that was mostly traded by banks, hedge funds, and large corporations and companies during this time.

As a result of technological breakthroughs and the expansion of the internet, the Electronic Communications Network (ECN) was introduced in 1990 in the United States to facilitate electronic trading.

ECN made it possible to conduct trades outside of exchange in an environment that is decentralized. This made it possible for retail investors worldwide to trade regardless of where they were based or the time of day.

During this time, many online brokers emerged as market makers, using themselves as a gateway to the ECN network. This meant that these forex brokers could set their bid prices and ask prices, which is how these brokers make a profit for services rendered.

Online brokers place trades on the ECN network on behalf of their clients, selling the currency at an increased price than the broker bought it for, allowing them to profit from every trade order.

Retail Forex traders were allowed to sign up with online forex brokers who are connected to the ECN network, download a forex trading platform, and start placing trades within minutes.

Today's retail brokers now offer low minimum deposits as a result of the size of the Forex market, and the volume traded, the number of market participants and the liquidity of the market.

These advancements in forex trading, the internet, and technology have made it possible for anyone to join the forex market from initial investments as little as $100 and less while being able to open positions that are one hundred times, and more, that of actual capital as a result of the use of leverage ratios.

The forex marketplace has come a long way since the days that people exchanged goods with a horse and carriage.

 

Were there applications like the Forex in the older periods?

Applications that were like the forex trading we know today involve the barter system. 

 

1. Ancient Era

There are many instances of currency trading as well as exchange systems that were recorded for ancient times before the advent and evolution of the modern financial market.

During these times, there were Money-changers, who were people helping others to change money while taking a commission or charging a fee, who were residents in the Holy Land during the times of Talmudic writings, also known as Biblical times.

These money-changers often used city stalls during feast times, and they were also known as silversmiths or goldsmiths, who accepted goods and currency for their services rendered.

During the fourth century AD, the Byzantine government kept tight control on the exchange of currency. Papyri PCZ I 59021, circa 259/8 BC, indicates the occurrences of exchange of coinage in Ancient Egypt.

Currency, as well as exchange, were important elements in trade in an ancient world. It enabled people to buy as well as sell items including food, pottery, and numerous raw materials which could be used.

Many accounts showed how merchants traded and exchanged for a profit. If Greek coins held more gold than that of an Egyptian coin as a result of either its size or content, the merchant would barter fewer Greek gold coins for more Egyptian coins. They also bartered for more material goods to make a profit.

As a result of this process, most foreign currencies that are in circulation today had a value that was fixed to a specific quantity of a recognized standard, such as silver and gold.

 

2. Medieval Era

In the 1500s, the Medici family opened banks in foreign locations so that currencies could be exchanged on behalf of textile merchants. To facilitate these trades, banks created the “Nostro,” which translates to “ours” in Italian, which was an account book that contained two-columned entries.

These entries showed amounts of both local and foreign currency. It also showed information involved with keeping an account with a foreign bank.

During the 1700s, or 1800s, Amsterdam maintained an active forex market, and in 1704, foreign exchange took place between agents who acted in the interests of the Kingdom of England and the Country of Holland.

 

3. Early Modern Era

In 1850, Alex. Brown & Sons traded foreign currency and was a renowned, leading currency trader in the United States of America. In 1880, J.M. do Espírito Santo de Silva (Banco Espírito Santo) applied for and was subsequently permitted to participate in foreign exchange trading business.

The 1880s are considered by at least one verifiable source as the start of modern foreign exchange when the gold standard was started.

Before World War I, there was a lot of limited control over international trade. As a result of the onset of war, many countries abandoned the gold standard monetary system.

 

4. Modern Era

Between 1899 and 1913, the foreign exchange holdings of countries saw an increase of 10.8% per annum, while gold holdings increased by 6.3% annually between 1903 and 1913.

At the end of 1913, half of the foreign exchange in the world was conducted using the pound sterling. There was a significant increase in foreign banks that were operating within London's boundaries from 3 in 1860 to 71 in 1913.

By 1902, there were only two London foreign exchange brokers, and at the start of the 20th century, currency trading was mostly conducted in Paris, New York, and Berlin, with Britain remaining uninvolved in currency trading until 1914.

Between 1919 and 1922, the number of foreign exchange brokers increased to seventeen, and by 1924, forty firms were operating to exchange currencies.

In the 1920s, the Kleinwort family were renowned as leaders in the foreign exchange market, while Japheth, Montagu & Co., and Seligman were honorable mentions as significant forex traders back in the day.

By 1928, forex trading was crucial to the financial functioning of most major cities. Continental exchange controls along with other factors in Europe and Latin America slowed the attempt at wholesale prosperity from trade, especially for those of London in the 1930s.

 

5. Post-Modern Era

In 1944, the Bretton Woods Accord was signed, which allowed for currency pairs to fluctuate within a 1% range from the par exchange rate of the currency. In 1954 in Japan, the Foreign Exchange Bank Law was introduced.

As a result, the Bank of Tokyo became the center of forex exchange by 1954. During 1954 and 1959, Japanese laws changed to permit foreign exchange deals in more Western currencies.

The Bretton Woods Accord and fixed rates of exchange were ended by United States President Richard Nixon in 1971, and after the Accord ended, the Smithsonian Agreement allowed exchange rates to fluctuate by up to 2%.

From 1961 to 1962, the volume of foreign operations by the United Federal Reserve was still low. Those who were in control of exchange rates found that the boundaries of the Agreement were unrealistic, and the Agreement was ended.

In 1973 when none of the major currencies was maintained with a capacity for gold conversion, organizations started relying on reserves of currency instead.

Between 1970 and 1973, the trading volume in the forex market increased threefold, and as a result of this, some markets were “split” into a two-tier currency market with dual currency rates. This, however, was ended in 1974.

Telephones and telex systems that were previously used in forex trading for quotes were replaced by Reuters in 1973 by computer monitors and terminals.

As a result of the ineffectiveness of the Bretton Woods Accord and the European Joint Float, the foreign exchange markets were forced to close during 1972 and 1973.

In many major economies around the world, the state control of foreign exchange trading ended during this time as complete floating and free market conditions of modern times began.

Many trusted sources claim that the currency pair was traded by US retail traders in 1982, with additional currency pairs becoming available in the following year.

With changes that started in 1978, the People's Bank of China allowed some domestic enterprises to participate in forex exchange trading. In 1981, the South Korean government ended forex controls that were still in place. This allowed for free trade to occur for the first time.

In 1988, the South Korean government accepted the IMF quota for international trade.

There was intervention by European banks, which influenced the forex market in 1985, with a large portion of trades worldwide within the United Kingdom, resulting in the US having the second-highest participation in trading.

During 1991, Iran changed international agreements with some countries, moving away from oil-barter towards foreign exchange.

 

What are the Key Points of History in Forex Trading?

The key points that supported and drove the evolution of forex trading are as follows.

 

1. The Bretton Woods System 1944 to 1971

This is the first major transformation that the foreign exchange market experienced. The Bretton Woods System or Accord occurred close to the end of World War II.

The United States, Great Britain, and France met at the United Nations Monetary and Financial Conference in Bretton Woods to design a new global economic order.

This location was important as a result of the United States being the only country not affected by the war. Most of the prominent European countries were in shambles as a result of the war.

WWII boosted the US dollar from a failed currency after the 1929 stock market crash to a benchmark currency according to which other international currencies were compared.

The Bretton Woods Accord was established to create a stable environment that would allow global economies to restore themselves. This was done by creating an adjustable, pegged forex market.

An adjustable pegged exchange rate refers to a policy where a currency is fixed to another. During the Accord, other international currencies would “fix” their exchange rate to that of the US dollar, with the US dollar being pegged to gold.

This was because the United States held the most gold reserves in the world at the time, so most foreign countries would transact in USD as a result of this.

However, as a result of the fact that there was not enough gold to back the number of US Dollars in circulation, the Bretton Woods Agreement eventually failed.

The number of US Dollars in circulation increased significantly as a result of increased government lending and spending, leading to the suspension of the Bretton Woods Agreement in 1971 by President Richard Nixon.

 

2. The Start of the Free-Floating System

Once the Bretton Woods Accord ended, the Smithsonian Agreement was introduced as a similar resolve which allowed for an increased fluctuation band for currencies.

The United States pegged the dollar to gold at $38 per ounce, which depreciated the dollar. Under this Agreement, other major currencies also fluctuated by 2.25% against the US Dollar, with the USD still pegged to gold.

In 1972 the European community attempted to move away from dependency on the US Dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg.

However, both these agreements made mistakes, much like the Bretton Woods Accord, and in 1973, it collapsed and resulted in the free-floating system being shut down.

 

3. The Plaza Accord

During the early 1980s, the US Dollar had appreciated significantly against all other major currencies around the world. However, this made things challenging for exporters, and it resulted in the US account running a deficit of 3.5% GDP.

In response to this stagflation that began in the 1980s, Paul Volcker increased interest rates which created a stronger US Dollar at the expense of competitiveness of the United States industry in the global market.

Third-world nations were being crushed by the weight of the US Dollar, especially under debt, and this led to the closure of many American factories as there was no competition with foreign competitors.

In 1985, G-5, which consists of the most powerful economies in the world, namely the United States, Great Britain, France, West Germany, and Japan – sent representatives to a secret meeting at the Plaza Hotel in New York City.

However, what was meant to be a secret meeting was soon discovered, forcing G-5 to provide a statement that encouraged the appreciation of non-dollar foreign currencies.

This became known as the “Plaza Accord,” and following this, retail traders started to realize the potential for profit in the new world of currency trading. Regardless of government intervention, there were strong levels of fluctuations, and as a result of these fluctuations, there was profit.

 

4. Establishment of the Euro

Following WWII, Europe forged several treaties that were designed to bring countries in the region closer together. Amongst all these treaties, the most prolific had been the 1992 treaty known as the “Maastricht Treaty,” which derives its name from the Dutch city where the conference was held.

During this treaty, the European Union (EU) was formed, and it subsequently led to the creation of the Euro currency, which put together a cohesive whole that included several initiatives on foreign policy as well as security.

There have been several amendments to the treaty, but the information of the Euro gave European banks as well as businesses the distinct benefit that they could remove exchange rate risk in an ever-globalized economy.

 

5. The rise of Internet Trading

By the 1990s, the currency market had grown astronomically, and it was sophisticated and faster than ever. More retail traders could emerge, and individual traders could partake in trading forex, and with advancements on the internet and communication, the forex market became more accessible.

During this time, currencies that were previously excluded in totalitarian political systems could now be traded, and emerging markets, such as those in Southeast Asia, flourished, which attracted capital and currency speculation. 

 

How Popular is Forex Trading Now?

From when it all started until today, Forex trading has become one of the most lucrative and popular activities in the financial industry. The forex market is the largest, most liquid, most volatile market that sees trading volumes of more than $6 trillion traded daily.

The market participants that are involved today include diverse authorities, international banks, commercial banks, organizations, beginner traders, professional traders, and several others.

Big multinational trade organizations, financial companies, hedge funds, and various companies around the world need foreign currencies to run their trades. The forex market is also popular as a result of the fact that traders can conduct trades 24 hours a day, five days a week, except for holidays.

As currencies are traded in pairs, the foreign exchange market does not set the absolute value of a currency pair but determines its relative value by setting the market price of one currency if it is paid for with another. The first currency in the pair is the base currency, while the second is the quote currency.

Today, the forex market is one of the most popular financial markets because of the range of currencies that can be exchanged for others, including:

  • The United States Dollar (USD)
  • Canadian Dollar (CAD)
  • Japanese Yen (JPY)
  • Swiss Franc (CHF)
  • Australian Dollar (AUD)
  • South African Rand (ZAR)
  • New Zealand Dollar (NZD), and several others.

 

Forex trading has also reached such a high level of popularity that forex brokers are offering real accounts at lower minimum deposits, with transaction costs very low as a result of the high liquidity in the market.

The Forex market also offers retail traders with a range of trading opportunities to earn profits by using a range of forex trading strategies and several different trading tools, including:

  • Technical analysis
  • Fundamental analysis
  • Technical indicators
  • Various economic indicators
  • A range of trading strategies such as day trading, position trading, swing trading, and more.