What is Forex? Forex, or FX, is a shortening of the words foreign exchange, and the Forex market is where different countries trade one type of currency for another. For instance, the Chinese can trade their renminbi or yuan for American Dollar. The value of currencies on the Forex market is affected by supply and demand.
The Forex market actually began with the first international gold standard in 1875. At that time, every major economic power priced an ounce of gold at a certain number of their currency's units. This made it far easier for countries to trade among themselves without having endless bartering sessions, or even wars, to settle the trades.
Countries tended to go on and off the gold standard through the early 20th century and into the world wars until, after World War II, the final attempt at a gold standard appeared: the Bretton Woods System. This system used gold to trade between nations with currencies basing themselves off of an ounce of gold.
Unfortunately, even the Bretton Woods system of the gold standard proved impossible to support. Some countries are more efficient producers than others, and the resulting imbalances in trade made the gold standard unfavorable to less productive countries. A nation needs a lot of gold to support such a standard, and a trade deficit could drain the national coffers dry in a short time. Most of the world's economies had left the various types of gold standard behind shortly after the second World War ended, and the United States finally overturned the Bretton Woods Act in 1971.
Because of the decision to move beyond gold, the world's central banks had to decide how they would trade with other countries. The method ultimately decided upon proved to be the Forex market we use today.
In this market, banks from various countries bring different kinds of money to the proverbial table and trade a certain amount of one currency for a certain amount of another currency. Some currencies will float, which means their value can change based on momentary supply and demand. Other currencies are merely pegged to the value of another currency, which means they will always have exactly the same value compared to the currency they're pegged with.
The Forex market is split up into several different levels of access. At the very top are the central banks of the world, and below them are different companies such as hedge funds. At the very bottom of the hierarchy are individual retail investors, who have to pay the largest amounts of spread for each transaction they make.
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