Over $5 billion is traded each day across the globe, making FOREX (foreign exchange market) the largest market in the world. It even surpasses the stock market in daily trade volume. FOREX is an interesting space within the investing universe and has a bit of a dark past. So, what is it about this market that elicits such a large volume of trade?
Where it All Began
As international trade began to rise, the Bretton Woods agreement was introduced in 1944, making currencies convertible for trade. It also set fixed global exchange rates around the U.S. dollar, which was tied to the value of gold. The agreement collapsed in the early ‘70s when the ratio of foreign held U.S. dollars to gold became skewed, effectively ending the Bretton Woods system. Eventually, the world began to trade currency digitally with the bulk of trading being done via FOREX. The evolution of currency trading also led to a corresponding advancement of market regulation.
The Past is History
While other futures markets are heavily regulated, FOREX can be more lenient. In the early years of FOREX, the risk of encountering scams and fraudulent traders were high. Thankfully, self-regulated entities have risen to counteract the rampant fraud. The Commodities Futures Trading Commission (CFTC) and the National Futures Association (NFA) are reputable regulators in the United States. (All NFA members submit themselves to regulation compliance and arbitration.) However, their regulations have restricted currency trading in the U.S. pushing many FOREX dealers overseas. An investor can effectively trade currency futures through the CME products, but it is heavily recommended that you only trade with a registered broker who is a member in good standing with a recognized regulator.
Big Fish in a Big Pond
Banks and corporations contribute the most to the massive volume of trades that occur on FOREX. International corporations can use FOREX to increase the efficiency of running their global business as it makes it easier to exchange currencies across the globe. FOREX helps international trade and investments by establishing currency conversions to provide a more convenient way for international businesses to pay for and import goods. The foreign exchange market also allows companies to evaluate and trade currencies based on interest rates as well as provides a way to hedge against inflation. Trading currencies also allows a corporation to pay employees – and other expenses – across different currencies.
International corporations play a large, impactful role within this market. However, banks make up an even larger piece of the pie, and are considered to be the anchor of FOREX. Central banks, such as Citibank, play the largest role in the currency trading market. They may use it in an attempt to control money supply, inflation and interest rates, and can even use their monstrous capital to try to stabilize a market. For example, a bank might weaken its own currency during a deflationary period by increasing its supply of money to purchase a foreign currency. This, in theory, would weaken its currency, effectively increasing exports in the global market.
Investing in a foreign country’s currency is an interesting concept and can be beneficial in the right situation. However, the risk of fraud and the potential lack of profit diminishes the attractiveness of this investment opportunity from an independent standpoint. While currency trading may not be recommended for the individual investor, it has an impact on the global economy, international corporations, hedge funds and can serve as an economic health indicator.