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What is Forex? MT5

About Forex

What is Forex? It is an international currency market with the turnover from 3 to 4 trillion dollars for one trading day. Forex is considered the largest among all financial markets as its daily trade volume exceeds ones of the stock market and the futures exchange combined.

The modern structure of the forex market was established in the 1970s. Before this, the international financial market was represented by the Bretton Woods system. Then the International Monetary Fund was established to control the international financial and economic relations.

By the mid-1930s, London had become the center of the world financial trading and the British pound was given the status of the main currency used for trade operations and foreign-exchange reserves. Later, in the mid-1940s, the delegates from many countries gathered at the Bretton Woods Conference in order to set a new system of rules, institutions, and procedures to regulate the international monetary system. This was called the Bretton Woods system.

Bretton Woods system

According to the key provisions of the Bretton Woods system, any financial and economic relations between countries should be controlled by the International Monetary Fund. This led to the requirement to establish parities of currencies, so the US dollar gained the status of the reserve currency. The dollar`s exchange rate depended on the value of gold. Then one ounce of gold was worth $35. Members of the IMF could change the parities of currencies only with the consent of the this fund. The Bretton Woods system also implied convertibility of all currencies. Thus, in order to fully comply with this principle, all governments had to keep international reserves and intervene in foreign exchange markets.

By 1958, almost all European countries declared their currencies convertible. Japan also joined them in 1964. It was already clear at that time that the USA was no longer able to hold the value of gold at $35 and America was threatened by the dollar inflation. During these years, President Kennedy made several serious mistakes imposing a tax on the interest rate differential and limiting foreign loans. Consequently, a new market appeared which was called eurodollar.

Eventually, the devaluation of the pound sterling shattered the Bretton Woods system in 1967. In the 1960s, the US gold reserves fell sharply from 18 to 11 billion dollars. In the beginning of the 1970`s, there was a drop in the US interest rates which turned into the Dollar Crisis of 1971. In a short time, the market faced the strongest outflow of capital from the USA to Europe where interest rates were much higher.

At the end of 1971, the system of fixed exchange rates of one currency against others was abolished and developed countries accepted exchange rate fluctuations. As the US trade deficit was increasing, the states were forced to terminate convertibility of the US dollar to gold, which ultimately led to the devaluation of the US currency by 10%. As a result, the European and Japanese currency exchanges were temporarily closed and the Bretton Woods system was brought to an end.

European Monetary System

After the demise of the Bretton Woods system, global leaders gathered together to establish a new international currency system the main elements of which were intergovernmental organizations that regulated currency relations and convertibility of currencies. National currencies became the standard means of payment and international currency transactions were conducted through commercial banks.This is how the European Monetary System emerged. It fully formed in 1978. The EMS was based on the parity grid which permitted a currency to move up to a limit of 2.25% either side of its central rate.

The EMS implied the usage of the European Currency Unit (ECU), the formation and control of the currency exchange rates of the EMS member countries, the system of crediting the trade deficit as well as conducting all payments and transfers in a single currency.

The ECU was first adopted in March of 1979. The ECU exchange rate was calculated every day on the basis of the basket of the currencies of the European Community member states which included 8-12 currencies. At the same time, the exchange rate of these currencies was based on the US dollar. The European Currency Unit did not exist in the form of banknotes or coins, so it could not be used on the consumer market but only for non-cash transactions within the framework of the EMS as well as for determining the exchange rates of the member states. The ECU`s value depended on the price of gold on the London Stock Exchange and the exchange rate of the dollar on the national currency market. The ECU was eventually abolished and, on January 1, 1999, the euro became its successor. Today the single European currency has the same functions, moreover, it is introduced in a physical form, used on the consumer market, and is a reserve currency in many countries of the world.

Forex

As for currency trading, it began to develop in the 1970`s when fixed exchange rates were canceled. Trading was based on making profits from floating exchange rates.

Nowadays operations on the foreign exchange market are conducted through dealing centers, brokerage firms. A forex broker is a licensed company that has the right to provide access to currency markets. Over the past few years, brokers have significantly expanded a range of their services. Currently, in addition to the main trading instruments, forex brokers offer CFDs (contracts for difference) that allow clients to trade not only currencies but also financial assets on the commodity and stock markets. Forex trading is available from anywhere in the world, which is its main advantage over the stock exchanges. Having a computer and access to the Internet, traders can work at any time of a day or night as trading floors operate 24/5.

Trading is based on the difference between the best bid and ask prices of currency pairs at the particular moment of time. This difference is called a spread and its size determines the liquidity of the market. The higher the spread, the lower the liquidity of the market is.

That is why, the lowest spreads are offered for the most popular currency pairs.

Types of forex trading

There are three main types of trading on Forex such as intraday trading, swing trading, and long-term trading.

Intraday trading is characterized by the high market dynamics and limited risks which make it especially attractive for beginners. The main feature of this trading type is that all transactions are concluded within the same day without transferring positions overnight.

Swing trading has weaker dynamics. Swing traders who have just started working may think that the market is quite sluggish. This trading type implies that a position is open from 1 to 10 days with profits mostly obtained not from a number of transactions, but from the market movements. At the same time, swing trading requires much more investment than intraday trading.

Long-term trading will bring profits only to very patient traders who work with daily and weekly charts. In this case, deals can remain open up to several months and the volumes of investment, of course, are also bigger in several times. Moreover, a long-term trader may be out of the market during the period of correction. However, this type of forex trading has its disadvantages. The main one is that trading can not be stopped at any moment.

A trader`s psychological attitude also plays an important role in achieving success on Forex. It is necessary not only to be able to foresee the market movements using the tools of technical analysis but also to control your emotions and be patient and cautious.

 
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