Academy · Stage 1
The forex market
How the foreign exchange market works, who trades it, and how it became the largest financial market in the world.
What forex is
Foreign exchange is the market where one currency is exchanged for another. Every international purchase, investment or loan involves it, which is why it dwarfs every other market: the Bank for International Settlements measured average daily turnover at roughly 7.5 trillion US dollars in its 2022 survey.
There is no central exchange. Forex is a network of banks, dealers, funds, corporations and brokers trading with each other electronically, 24 hours a day from the Sydney open on Monday morning to the New York close on Friday evening.
A short history
Gold standard (1870s–1914). Major currencies were fixed to a set weight of gold, so exchange rates barely moved. The system broke down during the First World War when governments printed money to fund the fighting.
Bretton Woods (1944–1971). After the Second World War, 44 countries agreed to fix their currencies to the US dollar, and the dollar to gold at 35 dollars an ounce. This gave the world two decades of stable rates. It ended in August 1971 when President Nixon suspended the dollar’s convertibility to gold, an event still called the Nixon shock.
Floating rates (1973 onward). By 1973 the major currencies were floating freely against each other. Exchange rates now moved with interest rates, trade flows and sentiment, and a market to manage that risk grew rapidly around the big banks.
The Plaza Accord (1985). The US, Japan, West Germany, France and the UK agreed to weaken the dollar through coordinated intervention. It remains the clearest example of governments deliberately moving exchange rates, and it is why traders still watch official statements so closely.
The euro (1999). Eleven European currencies were replaced by one. EUR/USD immediately became the most traded pair in the world.
Retail access (late 1990s onward). Internet trading platforms let individuals trade currencies with small accounts and high leverage for the first time. The retail forex industry, and most of the education around it, dates from this period.
Today. Trading is overwhelmingly electronic and algorithmic. Spreads on major pairs are fractions of a cent. Central bank policy is the dominant driver of the major currencies.
Who trades forex
Central banks set interest rates and occasionally intervene directly.
Commercial banks make markets and handle client flow. A handful of them account for most volume.
Corporations convert revenue and hedge future payments.
Investment funds take positions on rates, growth and risk appetite.
Retail traders trade through brokers, usually with leverage.
How a currency pair works
A price such as EUR/USD 1.0850 means one euro costs 1.0850 US dollars. The first currency is the base, the second is the quote. Buying the pair means buying euros and selling dollars.
Pip — the standard unit of price movement, usually the fourth decimal place (0.0001). For yen pairs it is the second decimal place.
Spread — the gap between the buy and sell price, which is the broker’s fee on most retail accounts.
Lot — a standard trade size of 100,000 units of the base currency. Mini (10,000) and micro (1,000) lots exist for smaller accounts.
Leverage — trading a position larger than your deposit. Regulated brokers in Europe and the UK cap retail leverage at 30:1 on major pairs.
What moves currencies
1
Interest rate differentials. Money flows toward higher yield. Central bank decisions and the expectations around them are the single biggest driver.
2
Inflation and growth data. Because they change what the central bank will do next.
3
Risk appetite. In calm markets, higher-yielding and commodity currencies tend to rise. In stress, the dollar, yen and Swiss franc tend to strengthen.
4
Trade and capital flows. Slow-moving but persistent.
5
Politics and intervention. Elections, sanctions and official statements.
Trading sessions
Asia (Tokyo, Sydney): quieter, yen and Australian dollar most active.
London: the largest session, roughly a third of global volume.
New York: overlaps with London for four hours in the afternoon UK time, which is the most liquid window of the day and when most US data is released.
RISK DISCLAIMER
Praevis publishes education and market commentary. Nothing here is investment advice. Trading forex, stocks and CFDs carries a high level of risk and may not be suitable for all investors.