Forex Market History

While the Forex market is the biggest market in the world, it didn’t get that way overnight. In fact, there was plenty of trial and error. There were a few systems that were tested and failed before they created the system we see today.

It is important that you understand what happened that led up to the current Forex market currency trading system to understand how things work now. If you are new to the Forex market, or trading in general, this information will give you a good deal of insight. Below are a few important moments in the history of the Forex market to help explain the birth of the Forex market currency trading system we see today.

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Gold Standard System:

The Gold Standard monetary system is known worldwide. It was created in 1875 but it is no longer in effect. In fact, before the gold standard system gold and silver were only used in international payments for currencies. When the gold standard system was in affect it was determined that all major countries defined the amount of currency per ounce of gold which was done by the late nineteenth century.

The exchange rate was determined by the price of an ounce of gold between two currencies. Each country had its own value per ounce of gold. The gold standard began breaking down by the beginning of World War I, and dropped again by World War II. While the Gold Standard system had broken down by this time, gold and silver still continued to be a major value when it comes to currencies over the years.

Bretton Woods System:

When the gold standard system fell they worked to create what was called the Bretton Woods System. This system was created by over 600 representatives of the Allied Nations. A combination of people is from each of the Allied countries. In 1944 these representatives met in Bretton woods, New Hampshire to create what was known as the Bretton Woods System of International Monetary Management.

The Bretton Wood System did three things including, created fixed rates for currencies trading, made the US dollar the primary world reserve currency, and created three major agencies to oversee the world’s international economic activity which still affect the financial market today.

International Agencies Created are:

IMF: International Monetary Fund

The IMF was created in July of 1944. It was designed to help oversee world economic activities for the financial market. Currently the IMF has 3 roles which include promoting global monetary and exchange stability, establishing a system of payments for global currencies transactions, and facilitating expansion of international trade.

They complete this by:

  • Surveying and monitoring both economic and financial development
  • Providing technical assistance and training for countries requesting help
  • Lending funds to countries with balances of payment difficulties

IBRD- International Bank for Reconstruction & Development

(Currently part of the World Bank)

A component of the United Nations World Bank Group and created in 1945, the IBRD provides funding towards post World War II rebuilding efforts. The IBRD was created to help regulate world economic activities as it effects currencies, and now helps below poverty loans to countries in need to help lessen the global poverty level. The IBRD received an annual donation of $10-15 million dollars which it uses in these efforts.

GATT- The General Agreement on Tariffs and Trade-

(GATT is the precursor to the World Trade Organization)

The General Agreement on Tariffs and Trade was a treaty that was formed in 1947 to help aid in economic recovery after the World War II. It was developed and signed into international law in January of 1948. Though it was replaced by the World Trade organization in 1995, it is still a part of the WTO today. Its main focus is regulating economic factors within world trade activities.

By the 1970’s the US reserves were so depleted that the treasury didn’t have enough gold to cover all the US dollars acquired by the foreign central banks. In 1971 the Bretton Woods system was dissolved. And new tactics where implemented to help improve the international currencies trade market. It is important to note that no currencies today are backed by the gold standard system.

The Jamaican Agreement

In 1976 the Jamaican Agreement was created which allowed for more floating foreign exchange rates. There were 3 different types of exchange rate systems developed. These assist in some types of regulation of foreign exchange rates. Below are the three Exchange Rate Systems:

  • Dollarization
  • Pegged Rate
  • Managed Floating Rate

Dollarization-

When a country decides to use the Dollarization system they are essentially giving up their right to produce their own currencies. This means that they adopt another countries currency as their primary currency. The foreign currency becomes an extension of their own country. The term “Dollarization” comes from the fact that the US dollar is the most dominant currency in the world.

Pro: It provides stability for the country.

Con: The country’s central bank can no longer print its own currency, nor create any monetary policies.

Pegged Rates-

When a country uses Pegged Rates as their exchange system, the country fixes its exchange rate to another foreign country. This means that their currency rates only change when the pegged country’s rates change.

Pro: If the pegged country’s currency appreciates so does the rate of their currency.

Con: Their currency is at the mercy of the pegged currency’s economic situation. So if the pegged country’s economic situation worsens and their currency depreciates, so does their currency.

Managed Floating Rates-

When a country decides to use the managed floating rates for their exchange, it means that their currency’s exchange rate is allowed to freely change in value according to supply and demand. It also allows the government of the country to intervene if rates go below unacceptable exchange rates.

Hedge Risks and Rewards

While trading is a very risky business, understanding the use of Stop Loss (SL) and Take Profit (TP) orders is important in being successful in the currency exchange. These, however, are used to hedge your risks and realize your profits in addition to ensuring you minimize your losses.

A Stop Loss order is a bit of protection on your investment. If you have a Stop Loss order placed on your trade order and the trade rate drops too low, the trade is closed automatically with the Stop Loss. This means that while your profit or gain can be sky high the amount of loss is not more than your initial investment or whatever amount you choose, which could be higher than your initial investment.

You can still close the trade, however, without waiting until you lose your entire investment. But if you are not able to watch the market 24 hours a day, than this safety precaution helps keep you from going below your invested amount. In addition, if you have leverage on the currency trade you might want to stop the Forex market trade early because you would still be responsible for the full investment amount and not just a portion of the trade amount.

But when it comes to profit, your gains can be immense. Especially if you have a leveraged trade because with investments sometimes as low as $100 to $10,000 you can gain more than you would with your original $100 up front amount. The gains can go through the roof, but remember that with more investments there is more risk of loss.

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