FOREX stands for foreign exchange – the financial exchange on which governments, banks, international corporations, hedge funds, and individual investors exchange foreign currencies.

The off-exchange foreign currency, or Forex, market is a large, growing and liquid financial market that operates 24 hours a day. It has no central trading location or exchange with many buyers and sellers. Most of the trading is conducted by telephone or through electronic trading networks. Banks, insurance companies, large corporations and other large financial institutions all use the Forex markets to manage the risks associated with fluctuations in currency rates. In recent years, however, a number of firms have begun offering Forex contracts to individual investors.

Previously the large amounts of deposits required precluded the smaller investors. In the past, participants were central banks, commercial banks, large institutions and high net worth individuals. But with the advent of the Internet and increasing competition the FX market is now a viable option for most investors.

History of the Forex Market

The Foreign Exchange market, ("FX or Forex") as we know it today, originated in 1973. The first major transformation, the Bretton Woods Accord, occurred toward 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, New Hampshire to design a new economic order. The Bretton Woods Accord was established to create a stable environment by which global economies could re-establish themselves. It established the pegging of currencies to the US dollar and the International Monetary Fund ("IMF") in hopes of stabilizing the global economic situation.

Currencies were allowed to fluctuate by one percent on either side of the set standard. When a currency's exchange rate would approach the limit on either side of this standard, the respective central bank would intervene, thus bringing the exchange rate back into the accepted range. In addition to this, the US dollar was pegged to gold at a price of $35 per ounce. Pegging the dollar to gold and the pegging of the other currencies to the dollar brought stability to the world Forex situation. The Bretton Woods Accord lasted until 1971. Ultimately, it failed but did accomplish what its charter set out to do, which was to re-establish economic stability in Europe and Japan.

After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord but allowed for greater fluctuation band for the currencies. This agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values. The Smithsonian Agreement failed in 1973 and signified the official switch to the free-floating system. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated. From the 70s to the mid 90s, the Forex market had been reserved exclusively for high net worth individuals, multinational corporations, institutional investors, and central, investment and commercial banks. In 1989, Tim Berners-Lee invents the World Wide Web (www) working as a consultant with CERN (European Organization for Nuclear Research). When the “Internet” (interconnected set of distinct networks) was approved for commercial commerce in the early 90s, innovation and major advancements in technology emerged.

Financial firms, such as E-trade and Ameritrade introduced software applications to the retail public for trading financial instruments and securities over the Internet. Today, these software applications are commonly known as “trading platforms”. By the mid 90s, Forex Dealers or “Market Makers” began offering online Forex trading to retail investors. FX Dealers began offering both institutional and retail investors access to the spot Foreign Exchange market via electronic trading platforms.  The major currencies often move independently of other currencies. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals.

In the past, the Forex market had been reserved for high net worth individuals and large institutions, such as banks, corporate enterprises, hedge funds and broker dealers. Today, with the introduction of the Internet and technological advancements in electronic trading, both smaller and medium size investors can now participate in the FX market, just as larger investors have been doing for the past 35 years.

Where is Forex traded?

Unlike the stock or commodities market, the spot Forex market is an over-the-counter (OTC) market. Retail customers trade directly with a counterparty and there is no exchange or central clearing house to support the transaction.

The off-exchange Forex market is the largest, most liquid financial market in world, operating 24 hours a day. Since there is no centralized exchange, most of the trading is conducted by telephone or through electronic trading platforms.

The primary market for currencies is the “interbank market” which consists of a network of banks, insurance companies, multinational corporations and other large financial institutions, such as central banks. The true interbank market is only available to institutions that trade in large volumes and meet the necessary credit requirements. However, many retail brokers offer access to the Interbank market through their liquidity partners, sometimes referred to as ECNs, “Electronic Communication Networks”. The primary difference between the Interbank market versus a “Market Maker” is the price or spread. Market makers offer fixed spreads. The true interbank market is only available to institutions that trade in large volumes and meet the necessary credit requirements.

The high liquidity in the Forex market is due to the enormous volume of transactions generated by the Interbank market where banks, large financial institutions, insurance companies and other large corporations deal with each other in huge quantities to manage their own currency risks. The secondary over-the-counter market, where retail clients participate in Forex transactions, has benefited from this liquidity provided by the big institutions.