Trading in foreign exchange or currency exchange rates, (also known as FOREX or FX trading), essentially consists of speculating on the way one currency will move against another, and profiting if they move the way you predict. All currencies are traded in pairs, for example GBPUSD, (Great British Pound VS US Dollar). An FX pair is always priced in the form of how many of the second currency you can get for one of the first. So, if GBPUSD is at 1.55, this means one pound will get you 1.55 dollars. As with other products, when you trade an FX pair, you buy or sell. When you buy the pair you are speculating that the first currency will strengthen against the second and vice versa for when you sell.
FOREX is the most widely traded product in the world. From the following chart you can see that daily FX trading turnover through main exchanges as risen from around $500billion in 1988 to over $3 trillion in 2007 and it is estimated that it is nearer $4 trillion today. It is one of the fastest growing markets for retail investors globally as it is open 24 hours a day and you can profit from both rising and falling prices.
Main foreign exchange market turnover, 1998-2010, measured in trillions of USD.
In 1944, the Bretton-Woods agreement was created to ensure stability of currencies by fixing gold at a rate of $35 per ounce. During this time most modern countries had gold based currencies, there was a period of stability. This system had weakness as the gold standard tended to create boom-bust economies. When an economy strengthened, the country would import heavily in order to expand. This would rapidly deplete their gold reserves and the gold was required to support their currency. The monetary supply of this country would also drop, interest rates would rise and all economic activity would dwindle or stop and threaten to put the economy into a recession.
After WWII, huge construction work was needed and a massive amount of currency trading was required to raise the capital for the work. In 1971 the Bretton-Woods agreement ended because the US dollar ceased to be exchangeable for gold. By now the forces of supply and demand controlled the currency prices of the major industrialised nations as currency was free to change hands. This encouraged larger volumes of trading and caused larger price fluctuations in a nation’s currency. Finally, with globalization and the development of computers and the internet, currency trading has become even easier and more accessible to both individuals and institutions, and thus the FOREX market has grown to the $4 Trillion daily turnover we see now.