Understanding the basics of forex trading
Trading foreign exchange with Dunhill Scott offers foreign exchange traders multiple goal achievement prospectives. Foreign exchange trading is the simultaneous buying of one currency and selling of another. The foreign exchange market (Forex or FX) is the largest financial market in the world with a daily turnover of over $3.2 trillion. Examples of currency trading pairs are Euro/US Dollar (EUR/USD) and US Dollar/Japanese Yen (USD/JPY). Most currency transactions involve the ''Majors''-the US Dollar, Euro, Japanese Yen, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.
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Unlike other financial markets, the foreign exchange market has no physical location and no central exchange. The Forex market operates 24 hours a day through an electronic network of banks, companies and individual traders. Forex trading begins every day in Sydney, and then moves to Tokyo, followed by London and then New York. The major market makers are consisted of commercial and investment banks, the exchange of traded futures and brokers all around the world.
Foreign Exchange Prices
Foreign exchange markets and prices are mainly influenced by international trade flows and investment flows. The Forex markets are also influenced, but to a lesser extent, by the same factors that influence the equity and bond markets: economic and political conditions especially interest rates, inflation, and political instability. These factors usually have only a short-term impact, which makes Forex attractive as it offers the investor some of the diversification necessary to protect against adverse movements in the equity and bond markets.
Foreign Exchange prices, or quotes, include a ''Bid'' and ''Ask'' similar to other financial products:
Bid: The price at which you can Sell currency pairs
Ask: The price at which you can Buy currency pairs
The difference between the Bid and Ask is called the ''Spread'', which is the Trader's cost of the transaction. Dunhill Scott Inc. offers to Traders the narrowest spreads in the retail Forex industry, thereby lowering your transaction costs
Currencies are usually quoted to four decimal places, such as the Euro/US Dollar trading at 1.1740/1743, with the last decimal place referred to as a ''point'' or ''pip''. A pip for most currencies is 0.0001 of an exchange rate; the one exception is the USD/JPY quote in which each pip is equal to 0.01.
The History of Forex
The history and evolution of the Foreign Exchange may be traced back to the early stages of human history. In the early days the goods were exchanged between individuals and the value of one good was expressed in terms of other goods. The limitations of this barter system encouraged traders to use other mediums such as stones, teeth etc. to determine the value of goods. These mediums soon to be replaced by precious metals in particular silver and gold thus providing an accepted way of payment in exchange of goods. It also had the many advantages such as storage and durability.
The introduction of Roman gold coin followed by the silver one played a key role in the development of the trade and foreign exchange during the biblical times. Both coins gained a wide acceptance in Middle East and other parts of the world forming an elementary international monetary system. By the middle Ages, increased usage of bills encouraged the foreign exchange to become a function of international banking.
The evaluation of the foreign exchange as briefly mentioned above was affected by many historical events. Study of such historical events is a personal choice. However with the attempts of governments to create a more stable economic environment for global trading and exchange, the last century witnessed some measures and events that shaped the current foreign exchange markets.
The Gold Standard, 1816-1933
Throughout the history, people began to realize the advantages of paper currency against the exchange of precious metals. Consequently stable governments eventually adopted paper currency and backed its value with gold reserves. This led to the introduction of gold standard.
The 'gold standard' used the physical weight of gold as the standard value for the money and making it directly exchangeable in the form of the precious metal. In 1816 for instance, the pound sterling was defined as 123.27 grains of gold on its way to becoming the foremost reserve currency and was the principal component of the international capital market. This led to the expression 'as good as gold' when applied to the Sterling, as the Bank of England at the time gained stability and prestige as the premier monetary authority.
Before the First World War, most Central banks supported their currencies with convertibility to gold. Paper money could always be exchanged for gold. However, for this type of gold exchange, a central bank coverage backing up the governments currency reserves was not necessarily needed. When a group mindset fostered a disastrous notion of converting back to gold in mass, panic resulted in so-called "Run on banks''. The combination of a greater supply of paper money without the gold to cover, led to devastating inflation and political instability.
As economies strengthened, heavy import of gold was required until the gold reserves reached the required level to back the existing paper money. Gold import was leading shrinking of money supply, high interest rates and slow economic activity to the point of recession. Ultimately, prices of goods had hit bottom, appearing attractive to other nations, which would rush into buying sprees that injected the economy with gold until it increased its money supply, and drive down interest rates and recreate wealth into the economy. Such boom-bust patterns prevailed throughout the gold standard until the outbreak of World War I interrupted trade flows and the free movement of gold.
The US dollar adopted the gold standard late in 1879 and became the standard-bearer replacing the British Pound when Britain and the other European countries came off the system with the outbreak of World War I in 1914. Eventually, though, the worsening international depression lead even the dollar off the gold standard by 1933 marking the period of collapse in international trade and financial flows prior to World War II.
The Bretton Woods System, 1944-73
Towards the end of World War II (July 1944) with the initiative of US, 45 countries met in a conference held in Bretton Woods, New Hampshire. The conference aimed to formulate a new international financial framework in order to prevent the reoccurrence of events such as the 1930s world depression and ensuring prosperity in the post war period. During the conference, John Maynard Keynes suggestion for a new world reserve currency in favor of a system built on the US Dollar was rejected. Instead, it resulted in a system of fixed exchange rates that reinstated The Gold Standard partly, fixing the USD at $35.00 per ounce of Gold and fixing the other main currencies to the dollar, initially intended to be on a permanent basis. The Bretton Woods system formalized the role of the US dollar as the new 'global' reserve currency with its value fixed into gold and the US assuming the responsibility of ensuring convertibility while other currencies were pegged to the dollar.
The post World War II period saw the British economy and confidence in ruins with infrastructure bombed, and their currency at a low. On the other hand, the US with its physical isolation was left relatively unharmed by war. This then has lead to the dollars rise to prominence becoming the reserve currency of choice and staple to the international financial markets. The establishment of the Bretton-Woods Accord is usually thought to have marked the beginning of foreign exchange. It was made to stabilize the global economy after World War II. It not only created the concept of pegging currencies against each other, but also created the International Monetary Fund (IMF) as well.
The Bretton Woods system came under increasing pressure as national economies moved in different directions during the 1960's. A number of realignments held the system alive for a long time but eventually Bretton Woods collapsed in the early 1970's following president Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer suited as the sole international currency when it was under severe pressure from increasing US budget and trade deficits. Up until its failure in 1971, the Bretton-Woods Accord did manage to stabilize the economies in Europe and Japan.
The End of Bretton Woods and Floating Exchange Rates
When Nixon suspended the gold convertibility in 1971, and the US dollar was no longer convertible into gold the Bretton Woods system finally went the way of history at the same time growing structural imbalances among the economies leading to mounting volatility and speculation in a one-year period, from June 1972 to June 1973. At the time the UK, facing deficit problems initially floated the Sterling, then devaluating further on in February of 1973 loosing 11 per cent of its value along with the Swiss Franc and the Japanese Yen. This eventually led to the European Economic Community floating their own currencies as well.
By 1973, currencies of major industrialized nations became more freely floating, controlled mainly by the forces of supply and demand which acted in the foreign exchange market. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, giving rise to new financial instruments, market deregulation and trade liberalization.
Smithsonian Agreement and the European Joint Float
At the core of Bretton Woods problems were deteriorating confidence in the dollars ability to maintain full convertibility and the unwillingness of surplus countries to revalue for its adverse impact in external trade. In 1971 and 1972 two more attempts at free-floating currency against the U.S. dollar, namely the Smithsonian Agreement and the European Joint Float were made. The first was just a modification of the Bretton-Woods accord with allowances for greater fluctuation, while the European one aimed to reduce dependence of their currencies on the dollar. After the failure of each of these agreements, nations were allowed to peg their currencies to freely float, and was actually mandated to do so by 1978 by the IMF. The free-floating system managed to hold out for several years, but many denominations had failed against the strong currencies.
Several times efforts for reestablishing controlled systems were undertaken with varying levels of success, the most well known of which Europe's Exchange Rate Mechanism of the 1990's that eventually lead to monetary union and today's 12 nation Euro. By that time the currency trading opportunities had begun to be enjoyed by not only those familiar with the Foreign Exchange market, but to people interested in investing in new markets.
The Introduction of the Euro
The Europeans were already very comfortable with the concept of forex trading, where much of the rest of the world were still unfamiliar with the territory. The European Economic Community introduced a new system of fixed exchange rates in 1979, the European Monetary System. The quest for currency stability continued in Europe with the 1991 signing of The Maastricht treaty. This was to not only fix exchange rates but also actually replace many of them with the Euro in 2002. The euro was the first single-currency used as legal currency for the member states in the European Union. It became the first currency able to rival the historical leaders in the Foreign Exchange market and create the stability that Europe and the forex market had long desired.
In Asia, the lack of sustainability of fixed foreign exchange rates has gained new relevance with the events in the latter part of 1997, where currencies were forced to float. Currency after currency was devalued against the US dollar. The devaluation of currencies continued to plague the currency trading markets, and confidence in the open market of forex trading was not sustained. Leaving other fixed exchange rates in particular in South America also looking very vulnerable.
While commercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have discovered a new playground. The size of the FOREX market now dwarfs any other investment market.
The last few decades have seen foreign exchange trading develop into the world's largest global market. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values. In the 1980s, cross-border capital movements accelerated with the advent of computers and technology, extending market continuum through Asian, European and American time zones. Transactions in foreign exchange rocketed from about $70 billion a day in the 1980s, to more than $3.2 trillion a day, two and a half decades later.