What is Forex?

If you have ever traveled internationally and exchanged your home currency for the local currency at an airport bureau or bank, you have participated in the foreign exchange market. You paid a price, the exchange rate, to convert one currency into another. Now imagine that transaction scaled to a global network of banks, governments, corporations, and traders, executing trillions of dollars in conversions every single day. That is the forex market.

A Brief History: How Modern Forex Began

The forex market as we know it today is relatively young. For most of modern economic history, currency values were not determined by free-market trading.

The Gold Standard Era

From the 1870s through the early 20th century, most major economies operated under the gold standard, a system where each country's currency was directly convertible to a fixed quantity of gold. This effectively fixed exchange rates between currencies. One British pound could buy a set amount of gold, and one US dollar could buy a different set amount, creating a stable (but rigid) relationship between the two.

The gold standard began to unravel during the economic crises of the 1930s. Countries abandoned gold convertibility one by one, Great Britain and Germany in 1931, the United States in 1933, France in 1936, as the rigid system proved unable to accommodate the monetary flexibility needed during the Great Depression.

The Bretton Woods System (1944–1971)

In July 1944, delegates from 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, to design a new international monetary order. The resulting Bretton Woods Agreement created a system where:

• The US dollar was pegged to gold at $35 per ounce
• All other major currencies were pegged to the US dollar at fixed exchange rates
• Countries could adjust their pegs only with IMF approval
• The International Monetary Fund (IMF) and the World Bank were established to oversee the system

This system provided stability for post-war global trade, but it depended on the United States maintaining enough gold reserves to back all the dollars in circulation. By the late 1960s, that was no longer feasible.

The Nixon Shock and Floating Rates (1971–Present)

On August 15, 1971, President Richard Nixon unilaterally suspended the dollar's convertibility to gold, an event known as the Nixon Shock. By March 1973, after severe dollar outflows and a brief suspension of forex trading, the major currencies began to float freely against each other, with exchange rates determined by supply and demand rather than government decree.

The transition to floating exchange rates was formalized by the Jamaica Accords in 1976. This is the birth of the modern forex market: a system where currency values are set continuously by market forces, economic data, interest rates, trade flows, geopolitical events, and investor sentiment.

How the Forex Market Works

It is Decentralized (OTC)

If you have traded stocks, you may be familiar with centralized exchanges like the New York Stock Exchange (NYSE) or NASDAQ, where all orders flow through a single matching engine. Forex does not work this way.

Instead, the forex market operates as a tiered network:

Tier 1, The Interbank Market: At the top are the world's largest commercial and investment banks (JPMorgan, Deutsche Bank, Citigroup, UBS, HSBC, and others). These institutions trade directly with each other in enormous volumes, individual transactions can be hundreds of millions of dollars. They set the benchmark exchange rates that flow down to every other participant.

Tier 2, Institutional Participants: Hedge funds, pension funds, insurance companies, large corporations, and smaller banks access the market through their relationships with Tier 1 banks. They receive slightly wider pricing than the interbank rate.

Tier 3, Retail Brokers and Traders: Individual traders access the market through retail forex brokers, who aggregate pricing from their liquidity providers (Tier 1 and Tier 2 banks) and offer it to clients. Retail traders see a further markup in the spread, though competition among brokers has driven retail spreads to historically low levels.

The Market Never Sleeps (Almost)

The forex market operates 24 hours a day, five days a week, across four major trading sessions that follow the sun around the globe:

The most active trading occurs during session overlaps, when two major centers are open simultaneously. The London–New York overlap (approximately 12:00–16:00 UTC) is the single most active period in the forex market, with the highest volume, tightest spreads, and most significant price movements.

According to the BIS survey, trading at sales desks in just five jurisdictions, the United Kingdom, the United States, Singapore, Hong Kong SAR, and Japan, accounts for 78% of all global forex trading.

Currency Pairs: The Language of Forex

In the forex market, you never simply "buy the euro" or "sell the dollar." Currencies are always traded in pairs because exchanging one currency inherently means receiving another.

Reading a Currency Quote

Let us break down the pair EUR/USD = 1.0850:

• EUR is the base currency (the currency you are buying or selling)
• USD is the quote currency (the currency used to express the price)
• 1.0850 is the exchange rate, it takes $1.0850 to buy one euro

If you buy EUR/USD, you are buying euros and selling dollars, you believe the euro will strengthen relative to the dollar (the rate will go up). If you sell EUR/USD, you are selling euros and buying dollars, you believe the euro will weaken (the rate will go down).

Major Currency Pairs

The most actively traded currency pairs, known as the "majors", all include the US dollar on one side. According to BIS data, the US dollar is on one side of 88% of all forex transactions.

Cross pairs are those that do not include the US dollar (e.g., EUR/GBP, EUR/JPY, GBP/JPY). They are less liquid than the majors but still actively traded.

Exotic pairs combine a major currency with a currency from a developing economy (e.g., USD/TRY, EUR/ZAR, USD/MXN). These tend to have wider spreads, lower liquidity, and higher volatility.

The Rising Chinese Renminbi

One of the most significant trends in the 2022 BIS survey was the Chinese renminbi (CNY/CNH) rising to become the fifth most traded currency, with a 7% share of global turnover, up from 4% in 2019 and jumping from eighth to fifth place. This reflects China's growing role in global trade and finance.

What Moves Exchange Rates?

While later sections of this academy will explore each of these factors in depth, it is useful to have a high-level understanding of why currency prices change:

Interest Rates: Central banks set benchmark interest rates that directly affect currency demand. Higher interest rates tend to attract foreign investment (to earn higher returns), increasing demand for that currency. When the Federal Reserve raises rates while the European Central Bank holds steady, USD tends to strengthen against EUR.

Economic Data: Reports on GDP growth, employment, inflation, trade balances, and manufacturing output signal the health of an economy. Stronger-than-expected data tends to strengthen a currency; weaker data tends to weaken it.

Geopolitical Events: Elections, wars, trade disputes, sanctions, and political instability can cause rapid and significant currency movements. The British pound's 10% drop during the Brexit referendum is a vivid example.

Market Sentiment and Risk Appetite: In times of global uncertainty, traders tend to move capital into perceived "safe haven" currencies (USD, JPY, CHF) and out of higher-yielding but riskier currencies. This dynamic, known as "risk-on / risk-off," can dominate short-term price action.

Trade and Capital Flows: Countries that export more than they import create demand for their currency (foreign buyers need it to pay for goods). Large cross-border investment flows, buying foreign stocks, bonds, or real estate, similarly affect exchange rates.

What the Forex Market is NOT

Given the hype and misinformation surrounding forex trading, it is worth being explicit about what the market is not:

• Not a get-rich-quick scheme. The forex market is a professional financial market where the majority of volume is generated by banks, institutions, and corporations for legitimate economic purposes, not speculative profit.
• Not a casino. While speculative trading involves risk, the forex market serves critical real-world functions: enabling international trade, allowing businesses to hedge currency risk, and providing central banks with tools for monetary policy.
• Not unregulated. While the OTC structure means there is no single global regulator, major jurisdictions have robust regulatory frameworks. The FCA (UK), ESMA (EU), CFTC/NFA (US), ASIC (Australia), and MAS (Singapore) all enforce strict rules on forex brokers.
• Not rigged against retail traders. While retail traders face structural disadvantages (wider spreads, less information, no direct interbank access), the market itself is too large and distributed for any single entity to manipulate. However, individual brokers operating in poorly regulated jurisdictions may engage in unfair practices, which is why broker selection matters.

The Scale of the Market: By the Numbers

To summarize the BIS 2022 Triennial Survey data that defines the modern forex market:

These numbers represent the market you are learning to participate in. Its sheer size provides the liquidity and opportunity that attract traders worldwide, but its complexity and the sophistication of its largest participants demand that you approach it with thorough preparation.

Key Takeaways

• Forex (foreign exchange) is the global marketplace for trading currencies, operating as a decentralized, over-the-counter network with no central exchange.
• The modern forex market was born in 1973 when the Bretton Woods system collapsed and major currencies began floating freely against each other.
• Daily turnover is $7.5 trillion, making forex roughly 250 times larger than the New York Stock Exchange by daily volume.
• Currencies trade in pairs. The base currency is what you buy or sell; the quote currency is the price. EUR/USD = 1.0850 means one euro costs $1.0850.
• The US dollar dominates, appearing on one side of 88% of all transactions. EUR/USD is the single most traded pair.
• The market operates 24 hours a day across four sessions (Sydney, Tokyo, London, New York), with the London–New York overlap being the most active period.
• Exchange rates are driven by interest rates, economic data, geopolitical events, market sentiment, and trade/capital flows.
• The forex market is hierarchical: the interbank market sets prices at the top, institutional participants operate in the middle, and retail traders access the market through brokers at the bottom of the chain.
• The Chinese renminbi is rapidly gaining importance, rising from eighth to fifth most-traded currency between 2019 and 2022.

This lesson is for educational purposes only. It does not constitute financial advice. Trading forex involves significant risk of loss and is not suitable for all investors.