The History and Structure of the Forex Market

The Bretton Woods System (1944–1973)

In 1944, 44 leading nations established the Bretton Woods system in New Hampshire, USA. This system created a new international monetary order:

  • Countries pegged their currencies to the United States dollar.
  • The US dollar was convertible into gold at a fixed price of $35 per ounce.
  • Central banks intervened (bought or sold their currency) to keep their currency stable within 1% of the pegged level.

The Shift to Floating Exchange Rates

The fixed exchange system ended in the early 1970s:

  • In 1971, the United States abandoned the fixed value of the dollar, allowing it to float (fluctuate) against other currencies.
  • By 1973, all participating nations agreed to allow their exchange rates to float freely.
  • Today: Most currencies are freely floating, with their price determined by demand and supply.

The Foreign Exchange (Forex) Market Overview

The foreign exchange market is the venue where currencies are traded. It is the world's largest financial market in terms of volume traded.

Market Growth (Average Daily Turnover)

  1. 1998: $1.7 trillion
  2. 2005: $2.2 trillion
  3. 2007: $3.5 trillion
  4. 2011: $4 trillion
  5. 2015 onwards: Over $5 trillion

Global Trading Centers (Daily Turnover Percentage)

  • London: 37% (The most important global center)
  • Singapore, Hong Kong, and Tokyo: 22% combined
  • New York: 19%
  • Europe: 8%
  • Switzerland and Australia: 2% each
  • Rest of the world: 10%

Market Characteristics and Trading Hours

The forex market is a global market with no physical location. It operates 24 hours a day, five days a week (Monday to Friday), operating continuously as major markets open and close.

Trading Cycle Example (GMT):

  • Sunday night (22:00): Trading starts in Sydney.
  • Tokyo joins Sydney two hours later.
  • 08:00: London opens.
  • 13:00: New York opens.
  • The period between 13:00 and 16:00 (when London closes) is the most liquid period with the highest volume.
  • 16:00: London closes; trading continues in New York.
  • 22:00: New York closes, and Sydney opens, restarting the cycle until Friday night.

Forex Market Participants

Three Levels of Market Access

  1. The Interbank Market: Where the biggest banks exchange currencies. This level processes most of the daily trading volume.
  2. Big Forex Brokers: These brokers have direct access to the interbank market and trade bulk amounts for their clients or smaller brokers.
  3. Small Forex Brokers and Retail Traders: Most retail traders cannot access the interbank market directly and rely on brokers to trade.

Main Categories of Participants

  1. Central Banks and Governments: Highly influential participants. Their main tasks include maintaining foreign reserve volumes and adjusting monetary policy.
  2. Commercial Banks and Transfer Companies: Conduct day-to-day operations (such as remittances and transfers) on behalf of clients.
  3. International and Commercial Companies: Involved in the market to facilitate international business (e.g., buying from suppliers). They often employ hedging strategies to reduce or eliminate foreign exchange risk.
  4. Speculators: Attempt to profit by taking advantage of fluctuating exchange rates. Speculators range from large hedge funds to small retail traders.

Understanding Currency Pairs

Trading in the foreign exchange market is always done through pairs. To buy one currency, you must simultaneously sell the equivalent quantity of another currency.

  • The first currency in the pair is called the base currency.
  • The second currency in the pair is called the quote currency.

Example: If EUR/USD is 1.1300, it means you must pay 1.13 US dollars (quote currency) to buy 1 Euro (base currency).

1. Major Currency Pairs (The Majors)

Majors have the US Dollar as one of the currencies. They account for 80% of daily traded volume.

The Seven Majors and Their Nicknames:

  • EUR/USD: Euro
  • USD/JPY: Dollar Yen
  • GBP/USD: Cable or Sterling
  • USD/CHF: Swissy
  • USD/CAD: Loonie
  • AUD/USD: Aussie Dollar
  • NZD/USD: Kiwi

Features of Majors:

  • Very liquid (heavily traded).
  • Not very volatile compared to other pairs.
  • Very difficult, if not impossible, to manipulate.
  • Characterized by very low transaction costs due to high liquidity.

Advice: Beginning forex traders are strongly advised to trade only the major pairs.

2. Cross Currency Pairs (The Crosses)

Crosses are currency pairs that do not involve the US Dollar.

The name "cross" is derived from the fact that historically, trading these pairs required first trading against the US dollar (e.g., converting Euro to USD, then USD to Yen), effectively "crossing out" the US dollar to get the direct rate (EUR/JPY).

Most Actively Traded Crosses:

  • EUR/JPY, NZD/JPY, GBP/JPY
  • EUR/GBP, EUR/CHF
  • AUD/JPY, NZD/AUD

Features of Crosses:

  • Less liquid (not as heavily traded as majors).
  • More volatile compared to the majors.
  • Slightly easier to manipulate than majors due to reduced volume.
  • Characterized by low to medium transaction costs.

3. Exotic Currency Pairs (Exotics)

Exotics include at least one currency from an emerging economy.

Examples of Exotics:

  • EUR/TRY (Turkish Lira)
  • USD/TRY, USD/MXN (Mexican Peso)
  • USD/ZAR (South African Rand)
  • USD/SGD (Singapore Dollar), USD/DKK (Danish Krone), USD/HKD (Hong Kong Dollar)

Features of Exotics:

  • Very illiquid.
  • Very volatile due to sensitivity to sudden political and financial developments.
  • Susceptible to manipulation due to very low volumes.
  • Characterized by very high transaction costs.

Advice: Only very experienced forex traders are advised to trade exotics.


Detailed Summary

The foreign exchange (Forex) market, the world's largest financial market by volume (over $5 trillion daily turnover), evolved from the Bretton Woods System (1944–1973), which pegged currencies to the USD and fixed the USD price to gold. This system dissolved in the early 1970s, leading to the current regime of freely floating exchange rates determined by supply and demand. The Forex market operates 24/5 globally, with London being the dominant trading center. Participants range from central banks and commercial companies to large speculators and retail traders. Currency trading always occurs in pairs, categorized into highly liquid Majors (involving USD), moderately liquid Crosses (excluding USD), and volatile, illiquid Exotics (involving emerging market currencies).

Key Takeaways

  • The Bretton Woods System (1944–1973) fixed global currencies to the USD, which was fixed to gold ($35/ounce).
  • The shift to freely floating exchange rates occurred in the early 1970s after the US abandoned the dollar's fixed value in 1971.
  • The Forex market is the world's largest financial market, with an average daily turnover exceeding $5 trillion since 2015.
  • The market operates 24 hours a day, five days a week, continuously cycling through global trading centers.
  • London is the most important global center, accounting for 37% of daily turnover.
  • The most liquid trading period is typically between 13:00 and 16:00 GMT (when London and New York overlap).
  • Market access is tiered: the Interbank Market, big brokers, and finally small brokers/retail traders.
  • Main participants include Central Banks (managing reserves/policy), Commercial Banks, International Companies (hedging risk), and Speculators (seeking profit from fluctuations).
  • Currency trading involves pairs (Base currency/Quote currency).
  • Major Currency Pairs (Majors) include the USD, account for 80% of volume, are highly liquid, and have low transaction costs.
  • Cross Currency Pairs (Crosses) exclude the USD, are less liquid than Majors, and are more volatile.
  • Exotic Currency Pairs (Exotics) include emerging economy currencies, are very illiquid, highly volatile, and have very high transaction costs.