financial market. Trader’s purpose on the Forex to get profit as the result of foreign currencies
purchase and sale. The exchange rates of all currencies being in the market turnover are
permanently changing under the action of the demand and supply alteration. The latter is a strong
subject to the influence of any important for the human society event in the sphere of economy,
politics and nature. Consequently current prices of foreign currencies, evaluated for instance in
US dollars, fluctuate towards its higher and lower meanings.
Using these fluctuations in accordance with a known principle “buy cheaper – sell higher” traders
obtain gains. Forex is different in compare to all other sectors of the world financial system
thanks to his heightened sensibility to a large and continuously changing number of factors,
accessibility to all individual and corporative traders, exclusively high trade turnover which
creates an ensured liquidity of traded currencies and the round – the clock business hours which
enable traders to deal after normal hours or during national holidays in their country finding
markets abroad open. Just as on any other market the trading on Forex, along with an exclusively
high potential profitability, is essentially risk - bearing one. It is possible to gain a success on it
only after a certain training including a familiarization with the structure and kinds of Forex, the
principles of currencies price formation, the factors affecting prices alterations and trading risks
levels, sources of the information necessary to account all those factors, techniques of the analysis
and prediction of the market movements as well as with the trading tools and rules.
An important role in the process of the preparation for trading Forex belongs to the demo-trading
(that is to trade using a demo-account with some virtual money), which allows to testify all the
theoretical knowledge and to obtain a required minimum of the trade experience not being
subjected to a material damage.
A short history about the origin and development of the currency exchange market. Currency
trading has a long history and can be traced back to the ancient Middle East and Middle Ages
when foreign exchange started to take shape after the international merchant bankers devised bills
of exchange, which were transferable third-party payments that allowed flexibility and growth in
foreign exchange dealings.
The modern foreign exchange market characterized by periods of high volatility (that is a
frequency and amplitude of price alteration) and relative stability formed itself in the twentieth
century. By the mid-1930s London became the leading center for foreign exchange and the
British pound served as the currency to trade and to keep as a reserve currency. Because in the
old times foreign exchange was traded on the telex machines, or cable, the pound has generally
the nickname “cable”. After the World War II, where the British economy was destroyed and the
United States was the only country unscarred by war, U.S. dollar, in accordance with the Breton
Woods Accord between the USA, Great Britain and France (1944) became the reserve currency
for all the capitalist countries and all currencies were pegged to the American dollar (through the
constitution of currency ranges maintained by central banks of relevant countries by means of
interventions or currency purchases).
In turn, the U.S. dollar was pegged to gold at $35 per ounce. Thus, the U.S. dollar became the
world's reserve currency. In accordance with the same agreement was organized the International
Monetary Fund (IMF) rendering now a significant financial support to the developing and former
socialist countries effecting economical transformation. To execute these goals the IMF uses such
instruments as Reserve trenches, which allows a member to draw on its own reserve asset quota at
the time of payment, Credit trenches drawings and stand-by arrangements. The letters are the
standard form of IMF loans unlike of those as the compensatory financing facility extends
financial help to countries with temporary problems generated by reductions in export revenues,
the buffer stock financing facility which is geared toward assisting the stocking up on primary
commodities in order to ensure price stability in a specific commodity and the extended facility
designed to assist members with financial problems in amounts or for periods exceeding the
scope of the other facilities.
At the end of the 70-s the free-floating of currencies was officially mandated that became the
most important landmark in the history of financial markets in the XX century lead to the
formation of Forex in the contemporary understanding. That is the currency may be traded by
anybody and its value is a function of the current supply and demand forces in the market, and
there are no specific intervention points that have to be observed. Foreign exchange has
experienced spectacular growth in volume ever since currencies were allowed to float freely
against each other. While the daily turnover in 1977 was U.S. $5 billion, it increased to U.S. $600
billion in 1987, reached the U.S. $1 trillion mark in September 1992, and stabilized at around
$1.5 trillion by the year 2000.
Main factors influences on this spectacular growth in volume are mentioned below. A significant
role belonged to the increased volatility of currencies rates, growing mutual influence of different
economies on bank-rates established by central banks, which affect essentially currencies
exchange rates, more intense competition on goods markets and, at the same time, amalgamation
of the corporations of different countries, technological revolution in the sphere of the currencies
trading. The latter exposed in the development of automated dealing systems and the transition to
the currency trading by means of the Internet. In addition to the dealing systems, matching
systems simultaneously connect all traders around the world, electronically duplicating the
brokers' market. Advances in technology, computer software, and telecommunications and
increased experience have increased the level of traders' sophistication, their ability to both
generate profits and properly handle the exchange risks. Therefore, trading sophistication led
toward volume increase.
Regional reserve countries. Along with the global reserve currency – U.S. dollar, there are also
other regional and international reserve countries. In 1978, the nine members of the European
Community ratified a plan for the creation of the European Monetary System managed by the
European Fund of the Monetary Cooperation. By 1999 these countries, which constituted socalled
Euro zone, have implemented the transition to the common European currency - the euro
(see Figure 1.1). The euro bills are issued in denominations of 5, 10, 20, 50, 100, 200, and 500
euros. Coins are issued in denominations of 1 and 2 euros, and 50, 20, 10, 5, 2, and 1 cent.
The euro is a regional reserve currency for the euro zone countries and the Japanese yen – for the
countries of Southeast Asia. The portfolio of reserve currencies may change depending on
specific international conditions, to include the Swiss franc.
The euro is a regional reserve currency for the euro zone countries and the Japanese yen – for the
countries of Southeast Asia. The portfolio of reserve currencies may change depending on
specific international conditions, to include the Swiss franc.
The role of the U.S. Federal Reserve System and Central banks of other G-7 countries on
Forex. All central banks and the U.S. Federal Reserve System (FRS) as well, affect the foreign
exchange markets changing discount rates and performing the monetary operations (as
interventions and currency purchases). For the foreign exchange operations most significant are
repurchase agreements to sell the same security back at the same price at a predetermined date in
the future (usually within 15 days), and at a specific rate of interest. This arrangement amounts to
a temporary injection of reserves into the banking system. The impact on the foreign exchange
market is that the national currency should weaken.
The repurchase agreements may be either customer repos or system repos. Matched salepurchase
agreements are just the opposite of repurchase agreements. When executing a matched
sale-purchase agreement, a bank or the FRS sells a security for immediate delivery to a dealer or
a foreign central bank, with the agreement to buy back the same security at the same price at a
predetermined time in the future (generally within 7 days). This arrangement amounts to a
temporary drain of reserves. The impact on the foreign exchange market is that the national
currency should strengthen. Monetary operations include payments among central banks or to
international agencies. In addition, the FRS has entered a series of currency swap arrangements
with other central banks since 1962. For instance, to help the allied war effort against Iraq's
invasion of Kuwait in 1990-1991, payments were executed by the Bundesbank and Bank of Japan
to the Federal Reserve. Also, payments to the World Bank or the United Nations are executed
through central banks. States foreign exchange markets by the U.S. Treasury and the FRS is
geared toward restoring orderly conditions in the market or influencing the exchange rates. It is
not geared toward affecting the reserves. There are two types of foreign exchange interventions:
naked intervention and sterilized intervention.
is also a monetary effect on the money supply. If the money supply is impacted, then consequent
adjustments must be made in interest rates, in prices, and at all levels of the economy. Therefore,
a naked foreign exchange intervention has a long-term effect.
Sterilized intervention neutralizes its impact on the money supply. As there are rather few
central banks that want the impact of their intervention in the foreign exchange markets to
affect all corners of their economy, sterilized interventions have been the tool of choice. This
holds true for the FRS as well. The sterilized intervention involves an additional step to the
original currency transaction. This step consists of a sale of government securities that offsets
the reserve addition that occurs due to the intervention. It may be easier to visualize it if you
think that the central bank will finance the sale of a currency through the sale of a number of
government securities. Because a sterilized intervention only generates an impact on the
supply and demand of a certain currency, its impact will tend to have a short-to medium-term
effect.
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