February 10, 2017
The rapid increase of turnover in the forex market started with the end of the Bretton Woods agreement in 1973. The agreement, established after World War II in 1944 to create a new international monetary system, made currency exchange rates fixed, and placed the U.S. dollar as the de facto world reserve currency backed by gold. Even today, the dollar remains world’s most trusted reserve currency.
The agreement also established two important international finance institutions:
- The International Monetary Fund, with the role to monitor the fixes exchange rate regimes, and to lend reserve currencies to countries.
- The World Bank, which helped in reconstruction of countries devastated by the consequences of World Wars I and II.
Eventually, the dollar overvaluation led to the collapse of the agreement in 1973, and foreign countries chose to let currencies float, which is one of the most important events in the history of forex.
Before the fall of the Bretton Woods agreement, large institutional investors were the exclusive participants in the foreign exchange market. Small investors couldn’t invest in the market. But, with the rapid technological development and the Internet boom in the 1990s, the forex market became accessible to smaller investors as well and thus, retail foreign exchange trading was born.
The retail forex market is where you and I can trade. This segment of the global forex market has approximately 5% of the share, which still represents over $280 billion in daily trading turnover. With the development of internet, trading software and the availability of trading on margin (that is, opening larger positions with only a percentage of your available balance), the retail forex market started growing. The following chart shows the growth rate of daily trading volume since 1989:
Most forex brokers are so-called market makers. A market maker buys and sells the currencies from its clients, making profit on the small price differential called a spread. When you exchanged currencies for a holiday trip to Europe, maybe you noticed the “bid” and “ask” price of a foreign currency in the bank. These are the prices at which banks (and market makers) buy and sell the currency from you, making a profit from the difference in the price.
On the other hand, an ECN broker uses electronic communication networks (ECNs) to give clients direct access to other market participants, like banks. This means that ECN forex brokers have tighter spreads than other retail forex brokers, but usually require a higher minimum deposit to start trading.