This article traces the evolution of the forex market from its early beginnings to its present day. It answers the question: how did the business of trading money come about? Read and understand how forex trading came about.
Forex trading simply means buying and selling currencies with a view to making a profit from the transaction. It is a bit like being a grocery store owner, where the grocer buys goods and resells them at a higher price to make a profit. In forex trading, the trading entity aims to make money from the minute-by-minute differences in the exchange rates of two currencies that are paired with each other. Forex trading came about as many governments decided to “float” the rates at which their currencies can be exchanged. The process of floating allows a currency's value to be determined by the forces of supply and demand. But was this always the situation? Let's delve a bit deeper into the history of the forex market to see how we got here.
Money has evolved over several centuries, from the time when cowrie shells, manillas, silver and gold were used as a means of exchange, all the way to the use of paper money. Even though gold is no longer used in everyday transactions as legal tender, it still plays a pivotal role in how the forex market evolved into a 24-hour business of trading money. Indeed, gold was still used as a means of exchange up until the late 19th century, when paper notes began to be introduced.
The 2nd World War and its aftermath was to define the future of money and change it forever. At that time, paper notes and coins were the universal means of exchange and countries which were under colonization used the currencies of their colonial masters. WWII pitched the Nazi-led coalition against the British-led Allied Forces. By the time the war entered its 5th year in 1944, the economies of the countries that were in active combat were virtually in ruins, as all economic and human resources had been mobilized for the war effort. The United States only joined the war in 1941 after Pearl Harbor was bombed by Japanese warplanes, and therefore did not suffer much of the economic downturn that Britain and Europe had suffered.
This was the backdrop on which the economic conference of Bretton-Woods, New Hampshire was held in 1944. The essence of this conference was to chart the course of the post-war world economy. One of the decisions reached in that conference was the introduction of the gold-standard; a means of stabilizing exchange rates by pegging an ounce of gold to the US Dollar. The US Dollar was chosen as the reserve currency for international transactions and the gold peg because it had not suffered the economic devastation that had befallen Britain and other nations fighting under the banner of the Allied Forces.
The US gold standard was to last for a total of 27 years. By 1971, the US government of Richard Nixon, financially stretched by the protracted conflict in Vietnam, abandoned the peg which at this time had doubled to $70 per ounce of gold. The government scrapped the use of gold as the backing standard for the US-dollar, and introduced a floating exchange regime where the rate of exchange of the US Dollar would be determined strictly by market forces.
This move therefore formed the basis on which currencies are bought and sold today as the forex market. If the exchange rate were to continue being fixed by government fiat, then there would be no exchange rate differential to profit from. But by introducing a flexible regime where the market determines the rates, it is possible to profit from buying/selling two currencies against each other.
Following the abolishment of the USD-gold peg, other pegs that had been maintained by other countries to the US Dollar all gave way to floating exchange rate regimes. But throughout the 1970s to the mid-1990s, trading of currencies was only limited to banks, hedge funds and major financial institutions. This was because currencies had to be traded in very large volumes, which meant that retail investors had absolutely no chance of participating in this market.
The coming of the internet and advances in information and communications technology was to revolutionize the market forever. With the internet and ground-breaking trading platforms, traders could connect with brokers, market makers and liquidity providers all with the click of a mouse button.
Here is a summary of the history of the forex market to date, detailing important milestones.
Pre-1944
– Paper currency in use around the world, but strictly used as legal tender and a means of exchange for goods and services.
1944
– Bretton-Woods Conference is held in the town of Bretton-Woods, New Hampshire, USA to discuss structure of post-war global economy. Outcome of meeting led to formation of the International Bank for Reconstruction and Development (World Bank) as well as changes to international trade and currency systems.
– The US Dollar is pegged to an ounce of gold at a price of $35 an ounce, and the US Dollar becomes the international reserve currency, leading to pricing of commodities and international transactions in US Dollars.
The 1970s marked the era where profound changes occurred in the forex market, leading up to the 1980s when a new generation of information and computational technology totally transformed the business of forex trading. Here are the remarkable milestones of this era.
1971
– By this time, the value of the US Dollar-gold peg is no longer $35 an ounce. It has gone up to $70 an ounce.
– Unable to bear the cost of sustaining the peg at the expense of the national currency, US President Richard Nixon decides to abolish the peg. This means that the US Dollar's value is no longer gold-backed, but rather backed by the US Federal Reserve. This change means that the US Dollar's value would now be determined by market forces.
– At this time, trading of forex is only done by banks and institutional firms such as hedge funds, as the volumes and costs associated with forex trading are still too great for individuals to engage in.
The 1990s came with more technology and changes to regulation that made it possible for individuals to start trading forex. The internet had started to become mainstream, and the first internet browsers were launched. The 1990s also saw the launch of the technologies such as trading platforms for desktops and laptops, and electronic communication networks for direct access to the interbank forex market.
For the first time, brokers known as market makers were able to come into the space, taking up large volume positions and reselling same to their customers in smaller bits with the provision of leverage. This allowed retail traders to trade smaller FX positions than the banks and institutional players.
The early platforms were bulky, slow and did not have a lot of functionality. At this time, only desktop versions were available; there were no web-based versions, and since there were no smartphones or app stores, mobile apps for trading were also non-existent.
1994
– The first internet browsers started to come on stream, led primarily by Microsoft's Internet Explorer, Netscape Navigator and Mozilla Firefox. The advent of internet browsers allowed forex brokers to set up websites and create downloadable trading platforms for use on desktop computers and laptops.
1997
– Forex trading is deregulated, allowing participation of individual traders. The number of retail forex brokers starts to increase.
1998
– The Japanese banking crisis caused a collapse of several Japanese banks, caused a severe weakening of the Yen and created massive forex market volatility.
1999
– The Euro is introduced, and is expected to replace all national currencies of participating Eurozone countries by 2002. On forex platforms, the EUR/USD is introduced as a currency pair and eventually becomes the most traded currency pair in the FX market.
As internet access spread across the world, so also did the opportunities that came with this spread. Access to the forex market increased and this decade saw the proliferation of retail brokers in several jurisdictions. New platforms that changed the face of forex trading came on board. But this decade also saw some unsavoury incidents that had the collateral effect of also changing the way the forex industry conducted business forever.
2001
– The 9/11 terrorist attacks came with very intense market volatility in the first week following the attack. The US Patriot Act was passed in response to these attacks in 2001, setting the stage for more enhanced regulation destined to flush out illicit money flows from the financial system. Know-Your-Customer (KYC) protocols were enhanced, and the situation introduced international financial blacklists that placed restrictions on the ability of nationals and residents of certain countries to access the forex market.
– A blacklist from the Office of Foreign Assets and Control (OFAC) means that citizens of certain countries can no longer do business with US companies as a direct response to the September 11, 2001 terrorist attacks. Affected companies include a large number of forex brokers. By the end of the decade, the number of forex brokers operating in the US dwindled from more than 40 to just three. An increasing number of retail forex brokers outside of the US stopped accepting US citizens on their platforms.
2005
– Russian company Metaquotes Inc launches the MetaTrader 4 retail forex platform, which would go on to become the most successful and most widely used trading platform of all time. A number of retail forex platforms also hit the market.
2006
– The first smartphones are launched, and with the advent of the smartphones come new mobile-compliant trading platforms. For the first time, traders can trade forex on mobile devices.
– Zulutrade launches the first social trading platform.
2008
– The global financial crisis of 2008 rocks the financial markets and causes central banks to cut interest rates in a coordinated fashion. Several central banks launch coordinated quantitative easing programs to boost confidence in their various economies as well as the financial markets.
– The document (white paper) from a pseudonymous character Satoshi Nakamoto describes the workings of a new kind of technology known as the distributed ledger technology or the blockchain, as well as what would become the number 1 cryptocurrency in the world, Bitcoin. Bitcoin and other digital currencies created off smart contracts on new blockchain systems would in later years, play a major role in how traders fund and withdraw funds from their trading accounts.
2009
– In addition to the interest rate cuts of 2008, central banks across the world implement a series of measures to boost confidence in the financial system and improve liquidity in the financial markets. The so-called quantitative easing programs throw cheap cash into the financial space, leading to market recovery and more volatility of the forex market.
2010
– The Dodd-Frank Act is passed, and the Commodities and Futures Trading Commission (CFTC) sets new leverage requirements for retail forex trading in a bid to lock out “unsophisticated investors”. This is meant to stop retail traders without much investing knowledge from participating in risky markets.
– The successor to the MT4 platform, the MetaTrader 5, is released by Metaquotes. However, it struggles for several years to overtake the MT4 and many brokers decide to offer both platforms side by side, rather than phase out the MT4 totally.
2011
– The Swiss National Bank (SNB) introduces a peg which sees the Swiss Franc (CHF) trade against the Euro at 1.2000.
– The first effects of the Eurozone sovereign debt crisis are being felt in Ireland, Greece, Spain, Portugal and Italy. The value of the Euro plummets steeply, generating huge market volatility.
2012-2013
– The Sovereign debt crisis in Europe worsens, with Greece and Ireland getting substantial bailouts from the European Central bank, European Commission and the International Monetary Fund (IMF).
– The Euro drops to levels last seen in its early introduction years against major currencies.
2014
– A new kind of blockchain technology which has the ability to support smart contracts and create entire new ecosystems is described by then 20-year old Vitalik Buterin and his team of co-founders. The so-called Ethereum blockchain would form the basis of for creation of several altcoins which are now traded as crypto CFDs on MT5 platforms.
– Quantitative easing is at its peak by 2014. Central banks starting considering the unwinding of these stimulus programs.
2015
– The Swiss National Bank abandons its EUR/CHF peg, causing an upheaval in the forex market. Several brokers who provided large leverage to their traders either go insolvent or lose colossal amounts of money. The event would later set the stage for a radical change in margin requirements for retail traders in 2018, spearheaded by the European Securities and Market Authority.
2018
– New rules for forex and CFD trading with regards to margin requirements as well as the scope, sale, marketing and distribution of leveraged FX and CFD products come into effect in Europe. Margin requirements for FX and CFD trading are raised significantly for retail traders, driving away many retail forex traders from European brokerages. EU brokerages respond by creating offshore branches, allowing their clients to choose to remain with the new trading conditions on the EU platforms, or to migrate to the offshore divisions where the old margin requirements can still operate legally. Distinction is now made between retail traders (unsophisticated with little professional experience) and professional traders (sophisticated traders with more than 2 years experience and who have access to a large capital pool). Margin requirements are left unchanged for the pro traders amid outcry as to the segregatory nature of the classification.
2019
– The first crypto CFDs were introduced to forex platforms, albeit in limited number.
– Crypto-based channels of transaction are introduced, enabling traders earlier locked out of the forex market by the restrictions imposed by FATF and OFAC, to get access to the market. No credit card or not allowed to wire money from your home country? Not a problem anymore as long as you had access to Bitcoin, Ethereum and other crypto-based transaction channels.
2020
– The year of the COVID-19 pandemic. With nearly everyone in the world locked up at home as part of governmental responses to the pandemic, billions of jobs all over the world were either lost, put in furlough or temporarily put on hold. With no way to make a living offline, many people were forced to turn to online methods of making money. Naturally, online trading became an item and what followed was a frenzy of account openings as desperation to start earning online from FX and CFD trading got to heights never before seen since the onset of retail forex trading in 1997.
– Central banks all over the world cut interest rates to near-zero levels to stimulate the global economy and stave off the crippling economic effects of the COVID-19 pandemic.
– Crude oil prices on the WTI benchmark go below zero for the first time in history, hitting -$37 a barrel as oil storage facilities get overwhelmed with supply amid near-zero demand due to global lockdowns that have shuttered all forms of transportation and industries. The volatility in oil prices creates massive opportunities for traders who trade the UKOIL and USOIL CFD contracts.
2021
– Australia's financial regulator introduced new margin requirements for traders categorized as retail traders. This followed the pattern already seen in the UK and Europe where the maximum leverage for major FX pairs was capped at 1:30.
– At around the same time, the first of the new-generation prop trading firms began to appear, offering traders enhanced capital if they could prove their expertise by passing a series of evaluations and challenges.
–The first signs of the revolutionary retail FX platform MetaTrader4 gradually falling out of favour and being replaced by the MetaTrader5, started to appear in 2021. By November 2021, Metaquotes Inc released data to show that server utilization of the MT5 increased to 63.3%, while it dropped to 36.7% on the MT4.
– As such, the MT5 has become a more popular trading platform among brokers, as it is more suited to multi-asset trading than the MT4, which was primarily built around the offering of FX pairs. Some brokers have stopped offering the MT4 altogether, preferring to offer the MT5. Data also show that most modern-day CFD traders find multi-asset trading more appealing than just trading FX pairs, which also explains the sharp spikes in user utilization of the MT5's servers.
2022
– The first signs of the inflationary impact of the stimulus programs of central banks across the world start to appear. It would take several months before central banks recognize the problem and start raising interest rates.
2023
– Interest rates across the world hit levels not seen in three decades as central banks struggle to get a grip on runaway inflation. There is massive volatility in the FX and CFD trading sector as the changes in interest rates create trading opportunities across several asset classes.
– There is a lull in new account openings as people get back to work, and are not as keen as they were in 2020 to open trading accounts with free cash from governments or in some cases, cash obtained from banks at very low interest rates.
2024
– At least three prop trading firms have shut their doors after their business models crumbled. In Europe, the European Securities and Markets Authority (ESMA) have begun holding consultations with industry stakeholders with a view to introducing a regulatory framework for the proprietary trading industry. This bit has been confirmed by Muinmos, a regulatory compliance firm. Currently, no major regulations exist for prop trading in many parts of the world, as the trading model does not involve receiving trading capital from clients or offering brokerage services.
– The cTrader has started to gain popularity with prop trading firms, as Metaquotes Inc has decided to end its cooperation with several of these firms. It has been 13 long years for the platform, whose time now appears to have come.
– AI and machine learning are gradually becoming mainstream. Do not be surprised when AI trading models are developed and sent into the market to knock off other human traders.