Where Did Money Come From
Since the beginning of time, merchants, traders and travelers have had to use some form of money that they could exchange in a new territory, or with neighbors that had measurable value. It was not for centuries that developed countries could expect to use letters or documents or forms of currency. You had to carry something that had value and that was easy to carry and conceal . Many times the equivalent value was unknown, perhaps a trader,would trade a bag of spice for a crate of tea and when he arrived at his destination port, they had no need for tea, or another ship had just arrived, so the value of the tea had gone down, or perhaps it was a British colony and there was a shortage of tea so the demand was up. This was a gamble to the traveler, and merchant alike. Or perhaps a rancher took his goats to the market and sold them, he needed to exchange the goats for something of value that he could carry and keep and use when he needed, such as money. Eventually most societies developed a monetary system, which worked just fine inside of their borders, but how did a Roman pay for food and horses in a foreign land. Would a merchant accept his Roman coins and if so at what value. Devloping Foreign Exchange This was the beginning of foreign exchange. Traders began to realize that they could work as intermediaries and take advantage of shifts in the markets and the demand for goods. A smart trader would know where there was a shortage of tea and an abundance of corn. As time passed, neighboring countries and trade regions, such as colonies and protectorates developed a monetary exchange system, so that a Spaniard could exchange his coins in a French territory for a set value and an Englishman could use his coins anywhere around the world. Eventually the gold standard was developed and countries would tie their money to the gold in the coins or the value of the paper money was backed by gold. Each country would set the value of their currency and would only make changes due to major changes in agriculture, war, weather, or growth and demand. There were no regulatory agencies, and a money broker could change the value for which he exchanged depending on his own requirements. But there was at least an assumed value. This was the beginning of currency conversion and foreign exchange rates. Import Export Markets The world of business and trade developed and expanded across borders, society and culture developed and a demand for foreign or unique products, governments realized that they needed a way to exchange large amounts of money so that they could expand their export and import markets. Jump Forward A Few Centuries Governments and Leaders knew they needed to set standards to value their currency and their economy as well as their national debt and budgets. For many years it was the job of the central banks in each country to monitor their currency value, process the exchange of currency from their local banking systems. Many governments even began to invest in other currencies, for instance holding their dollars instead of exchanging them gambling that the dollar would grow or the demand for dollars would increase, they could then sell these dollars back to their account holders at a profit. The Beginning Of The Modern Foreign Exchange Market (Forex) At a conference in Jamaica in 1976, the world governments agreed to accept a new floating currency system replacing the gold standard, this was the birth of the foreign exchange markets. Within a short time, you were able to buy and sell currency, and options on currency, in global markets, similar to stocks or commodities. The prices of the currency fluctuated and you could buy and sell currencies on the open market to take advantage of these shifts in value. Once the countries and currencies were openly and easily traded a global exchange was open. The value of currency is based on the demand for a currency by the market, as it is no longer tied to any real asset value. Currency rates move freely. Although the foreign exchange markets were developed for businesses and governments to exchange currency, today that only makes up a small percentage of the foreign exchange transactions. Investors saw ways to capitalize and profit on movements of currency. Also businesses that traded on an international basis realized they could buy or sell currency that they would need for future purchases when the currency values were higher or lower, giving them an edge in their business transactions. Investors Start Trading The Forex Market There are all sorts of investors in the forex market, day traders, speculators, long term traders, investor’s pension funds and institutional as well as banks. Everyone is looking for profit. Each investor is hoping that the markets move in their favor, in this market, there is a loser for every winner. Each currency trade is matched with a counterpart. If you purchase 100usd there needs to be someone willing to sell you 100usd and at what value. Currencies are always trade in pairs, when a trader makes a trade he or she is always long/buying one currency and short/selling the other. If a trader sells one standard lot (equivalent to 100,000 units) of EUR/USD, they would have exchanged euros for dollars and would now be “short” euros and “long” dollars. To better understand this dynamic, let’s use an exact example. If you went into a computer store and purchased a laptop for $1,000, what would you be doing? You would be exchanging your dollars for a computer. You would basically be “selling” $1,000 and “buying” one computer. The store would be “buying” $1,000 but now “selling” one computer in its inventory. The exact same principle applies to the forex market, except that no physical exchange takes place. While all transactions are simply computer entries, the consequences are no less real. Currency Pairs Why do you need to purchase currencies in pairs. Since you can’t buy a physical asset on the currency market, you need to trade against another currency. The value of a currency is only in relationship to a specific currency. If you were sure that the USD was going to move up today, would it be moving up against all currencies or against a specific currency. It might move up against the the Sterling, but the Swiss Franc might be strong today so the dollar falls against the CHF, so you have to select the currency that you wish to hedge pair with. You can simply buy dollars and hold them, but at some point you will have to do something with them, but you have dollars so why would you use those dollars to buy more dollars. If you wish to buy the Australian Dollar, you would have to use your US Dollar to make the purchase so you are pairing USD/ANZ. You would not buy the Australian Dollar if you thought it was going to go down tomorrow in value, you would wait till tomorrow where you could get move Australia Dollars for your US Dollars. Now you have it. This is the basics, except that in the forex market you can not simply buy or sell 10 dollars or 500 yen, you need to purchase contracts or lots. Currency does not fluctuate a great deal, the value moves in what are known as pips, 1000th of a cent, so you need to be able to purchase huge quantities of currency to make profit. This is done through leveraging and margins, which will discuss later. Let’s give you another easy to follow scenario. You are going to London on vacation. From London you are going to France. The UK currency is known as Sterling or the Great British Pound, GBP and France is part of the Euro. If you called and booked your hotel today and they required payment in advance in their local currency. What would you do? The agent in the UK told you that you needed to wire them 1000gbp and you checked with your bank and they told you that it was equal to 1600.00USD today and the agent in France said you needed to send them 1000euros and your bank told you that that was 1300.00. You heard on the news that the Euro was falling quickly because of economic problems in Europe, would you pay the bill today, or would you wait a few days and check with your bank again. When you do, you might find that 1000euros would only cost you 1250.00, you save or made 50.00, but at the same time they might just tell you that the 1000gbp would not cost you 1700.00 you lost 100.00. This is because currencies move in different relationships to other currencies. We will discuss currency pairs again in another article, so keep your eyes out of our next article. Remember to make money in the forex markets; education and knowledge is the key. How Do You Know What to Trade In order to make a successful trade you need to be able to predict market movement as well as determine entry and exit points and value. This is done by what is known as analysis, and there are two main types of analysis, these are fundamental and technical. Fundamental is based on news, information, facts, reports, and data. This information comes from many sources and the better the sources, the better your analysis. Most of the information comes from government economic data and reports and comments by acceptable sources such as the Director of the Federal Reserve, and then there are new sources, which affect the markets. If you knew the news from Libya, before it made the airwaves and internet sets, you could have bought oil before it moved up due to the shortage created a reduced production due to the war in Libya. There are government reports such as Jobs Report, Trade Balance, Housing Starts and Consumer Confidence. Lately a lot of press coverage has been on GDP and debt. Technical analysis is based on charts, graphs, historic information about price and movement. Technical analysis use charts and graph and apply formulas or rules to determine their results. These include Fibonacci Numbers, Pivot Points, MACD, Stochastic and Resistance/Support. Fundamental analysis is the easiest to understand, but it is as complex as technical analysis. To trade successfully in the forex market, an investor needs to know and understand how to interpret data and to forcast the markets reaction. This takes time and learning, understanding and perception. Let’s take a simple example. You move to a new home, across town, on the first day, you need to plot out how you are going to drive to your office. It is not difficult, but requires your full attention and you need to watch for street signs and landmarks. The first day the trip is long and slow, as you are stuck in traffic, you do not know the flow of the street lights or the patterns of traffic, you get stuck behind a school bus and then a garbage truck. The next day you review your route to see if there are alternatives. You begin to pay attention to the movement of the traffic, the time of day, the street lights, you begin to see how the traffic reacts at different times of the morning and on different days. After a month you have it down pat, you know if you see a yellow bus blocks ahead of you, to take a left and circle around, you know if you make the first light, that you can make all of them. You know exactly what time the kids start arriving at the school but you know all of this in the back of your mind, it just happens and flows. Of course you listen to the news and react on days that schools are closed or in the summer when the kids are out of school, or when there is construction. You are employing Fundamental Analysis. Technical analysis is a lot more complicated and a trader needs to learn and understand how numbers and cycles repeat themselves and how to find patterns in charts and then how to read those patterns. Most technical traders are professional traders, institutional traders or experienced traders. There are traders who only use Fundamental Analysis and there are traders who only use Technical Analysis. Good traders use both but rely heavily on of style or the other, but they know and understand each.