Forex Investment and Currency Trading

Today’s system of floating exchange rates is not a carefully planned system. Instead, it was one born by default as the Smithsonian Agreement and the European Joint Float failed to gain momentum. Yet the foreign exchange market is by far the largest and most liquid market in the world today.

The floating system allows the values of currencies to rise and fall based on the basic laws of supply and demand. When the supply of a particular currency is high, the price (relative exchange rate) of the currency begins to drop because there is more supply available than demand. The opposite is true when the supply of a currency is tight. When less money is available for trade, the price (relative exchange rate) of the currency goes up because more people want the currency than what is available for purchase.

Major currencies today move independently from other currencies. They can now be traded by anyone from individual retail investors to large central banks. Central banks do intervene occasionally to influence the exchange rate for their country’s currency.

What are the key developments that made the foreign exchange market so vibrant and liquid? These developments include the following:

• The flexibility countries have today to choose either a floating exchange rate or a fixed exchange rate.
• Financial deregulation moves throughout the world that included elimination of government controls and restrictions on foreign exchange in nearly all countries. This permits greater freedom for national and international financial transactions, and greatly increases global competition among financial institutions.
• Inter nationalization of savings and investments provides fund managers and institutions around the globe with large sums available for investing and diversifying across country borders to maximize returns.
• Broader trends toward international trade liberalization within a framework of multilateral trade agreements encourage the globalization of business.
• Major technological advances have led to rapid and reliable execution of financial transactions, to reduced costs, and to instantaneous real-time transmission of vast amounts of market information worldwide.

Forex Highlights

• There are two types of currency exchange regimes—fixed rate and floating. The developed countries all use a floating exchange rate. Many emerging countries use a fixed exchange rate, most often pegged to the U.S. dollar or a basket of currencies.
• Although the Bretton Woods Accord and its fixed exchange rate regime helped to rebuild the world economy after WWII, it ultimately failed.
• The Euro, the unified currency of Europe, was first adopted in 1999 and is rapidly becoming a key currency in the Forex marketplace.
• Today the foreign exchange market is by far the largest and most liquid financial market in the world.