The History of the Forex Market

by | Sep 8, 2019 | Forex history

The Forex market today

The foreign exchange markets are the original and oldest financial markets in existence, and still serve as the basis for the bulk of the financial structure and trade in the world: The foreign exchange markets offer international liquidity, with relative stability. In addition to trading and investment requirements, foreign exchange is also bought and sold for risk management (hedging), arbitrage and speculative profits. On a side note, the increasingly asymmetrical relationship between foreign exchange markets and national governments is a classic problem of autonomy.

The forex market is unique in several respects to other markets such as the stock market or real estate market, starting with the fact that it is the most liquid market in the business. While most of us are thinking about Monday through Friday standard working hours, when we think of Wall Street operations and traders looking at market figures, the Forex market covers currencies in different time zones.

The Forex market prior to WWI

From the early phases of foreign exchange trading in the Middle Ages to World War I, foreign exchange markets have been relatively stable and have lacked much speculative activity. After the Great War, foreign exchange markets became very volatile and speculative activity increased significantly. In the early days, speculation in the forex market was generally not considered a profitable endeavor by most institutions and the general public. The global economic crisis and the abrogation of the gold standard in 1931 led to a serious slowdown in the foreign exchange market.

Forex in the 20th century and the Bretton Woods Agreement

Prior to the 1970s, foreign exchange trading was mainly driven by large international corporations needing different currencies due to their global presence. However, currency trading has increased since the 1970s, both for operational and speculative purposes. The main participants in the foreign exchange market are large international banks, and financial institutions that facilitate trade between buyers and sellers.

In 1971, President Nixon was credited with ending the Bretton Woods Agreement, and currency trading was now a free-floating monetary system. There were several attempts to bring the currency back, but all attempts were foiled. Fluctuating exchange rates meant that the market would now determine the value of each currency through supply and demand. Traders could benefit from fluctuating prices by entering Forex trading at the right time.

Ever since 1995, individual traders have been able to trade currencies in real time over the Internet and through retail Forex brokers. The general interest in foreign exchange trading has grown steadily since 2002. Today, the foreign exchange market is the largest financial market in the world in terms of daily transaction volume, which is estimated at more than $4 trillion.

The Forex market is the trading of pairs of international Fiat currencies, which are linked to each other and where traders speculate and hedge the risk of a price increase or depreciation of one particular local currency against another currency. Interestingly, there is no central currency exchange, and all businesses are open 24 hours a day, more than 5 days a week, with OTC financial trading centers operating in major cities around the world.

The system behind the Forex Market

The Forex market is the trading of pairs of international Fiat currencies, which are linked to each other and where traders speculate and hedge the risk of a price increase or depreciation of one particular local currency against another currency. Interestingly, there is no central currency exchange, and all businesses are open 24 hours a day, more than 5 days a week, with OTC financial trading centers operating in major cities around the world.

Forex trading requires the existence of national currencies, which are generally accepted as value stores. Forex traders trade these national currencies in pairs, speculating on the strength or weakness of one currency over another. A currency with an artificial exchange rate set by a government is neither suitable for foreign exchange trading nor a currency that is very volatile due to political turmoil or hyperinflation.

The foreign exchange market originally operated under the central banks and state institutions, but later the various institutions housed it, including the dotcom boom and the World Wide Web. The size of the forex market now outshines any other investment market, and thus is the largest financial market in the world.

There is no need for a centralized trading venue as the Interbank Currency Exchange is the hub for all activities. With this immediate transmission of information, this market is moving fast and is one of the most accurate exchanges of the present. Now you know the history of the Forex market, how it came into being, and how you can benefit from it today.

Technology, the Internet and the Growth of Forex trading

Due to the expansion of technology and the Internet in the 1990s and beyond, it now became possible for every investor in the world to invest in the forex market. With the advent of electronic communication networks, it was not very easy to carry out forex trading transactions, while conveniently trading from home. The Electronic Communication Network (ECN) was introduced in 1990 in the United States to facilitate electronic commerce. It became easy for retailers to sign up and trade with the broker of preference connected to the Electronic Communication Network.

The Forex trading retail market is growing as we speak, with the advent of currency trading platforms and their easy accessibility on the Internet. Retail Forex traders indirectly access the market through either a broker or a bank. There are two main types of forex retail brokers that give us the opportunity to speculate in the foreign exchange market: brokers and traders.

The future of foreign exchange trading is characterized by some degree of uncertainty, and it is constantly changing.

This inadvertently leads to a long-lasting investment potential for Forex traders to benefit from the Forex market. For forex traders to succeed in a developing market, they must be ahead of the curve, utilize modern technologies and platforms, while being well-informed of trends and developments in politics and financial policies.

How to use the RSI Indicator

by | Jul 21, 2019 | Forex Indicators

What is the RSI indicator?

RSI stands for Relative Strength Index, and it has become one of the most popular technical indicators in the trading of stocks and Forex (Foreign Exchange).

Developed by J. Willes Wilder, and published in his 1978 book named New Concepts in Trading Systems, the RSI helps investors detect when prices are potentially overbought or oversold. It is a momentum oscillator, and can be used in trading any equity on financial markets.

RSI indicator; a very powerful Forex indicator for trading mainly range bound markets.
Here we see a range bound market, with clearly identifiable support and resistance levels. The trader sees that the asset has moved into overbought territory, then waits for a candle showing bears significantly stronger than bulls. A sell trade is opened. About three weeks later, the same asset is in oversold with RSI lower than 30. The trader opens a buy trade. Both trades turned out to be quite profitable.

The indicator measures both velocity and magnitude of directional price movements. Two parameters can be adjusted. The number of periods, and the level of the RSI itself. The standard settings for the indicator is 14 periods, overbought level to 70, and oversold level to 30.

Common use cases

Although the indicator is mostly used in non-trending markets, also referred to as range-bound markets, the RSI indicator can also successfully be applied when prices are trending. However, the indicator should not be used in the same manner in the above mentioned scenarios. (see below)

In investment theory, price is a result of the relationship between buyers, also known as bulls, and sellers, commonly referred to as bears.

When the bulls are stronger, and prices go up, it is expected that a retracement will take place at a certain time. When the RSI is in overbought territory, investors consider closing their buy positons. Conversely, when the indicator shows oversold, traders seek to open new buy trades, or close any open sell positions.

General guidelines for using the indicator

The indicator is most commonly used by swing traders. Swing traders recognize that price action is cyclical in nature, and features predictable and frequently occuring retracements. In the absence of trend, swing traders buy assets in oversold areas, and sell them in overbought areas.

If the indicator is set to a standard configuration of 14 periods, overbought at 70, and oversold at 30, traders will act below 30, and above 70. When trading Forex, swing traders open buy positions below 30, and sell positions above 70.

Although the indicator gives an indication of future direction, is is not particulary good for timing entries. Because of this, trades often use the RSI together with candle analysis. In the Forex market, investors known as scalpers, often wait for a strong move downward, to immediately open a buy trade and vice versa. They count on an instant pullback, after which they close their position with profit.

Alternatively, you can wait for price to move out of overbought or oversold, before taking action. This is important, especially if the market is trending strongly.

For both RSI and trend trading algos, be sure to visit our Forex Robot gallery.

RSI parameters

The RSI consists of two parameters. Number of periods and the RSI level itself. The higher or lower the level, the more extreme the overbought and oversold signals become, and the fewer trades you will make.

You can also adjust the sensitivity of the RSI, by simply reducing the number of periods e.g. when periods are set to 7, the indicator looks back only 7 previous candles, not the standard 14. For seeing how the RSI is calculated, click here.

Using the RSI in range-bound markets

In range bound markets, the indicator is in a league of its own. When trading the forex market, essentially you open buy trades when oversold, and sell trades when overbought.

You can choose to wait for confirmation, or be aggressive and trade when as soon as a candle opens in overbought or oversold areas. If you are trading stocks, you go long when the asset is oversold, and go short when overbought.

RSI Trading in a range bound market.
Here a trader has correctly identified a range bound market, and opens three trades. Two sell trades when the RSI hits 70 or above, and one buy trade when the RSI is at 30 or below. All three trades were profitable. The RSI is well suited for trading range bound markets.

Look for clearly identifiable support and resistance levels, when determining whether the market is range bound or trending.

Making use of the RSI in trending markets

Master traders know that in trending markets, you have to tread carefully with the RSI. When markets trend up, you can observe higher highs, and higher lows. Conversely, when markets trend downward, you will observe lower highs and lower lows.

It is therefore important to note, that in an upward trend, taking a sell trade in overbought territory is risky, as the trend might continue. This applies to oversold as well. (see chart below)

The correct way of applying the indicator in trending markets, is to take buy trades on pullbacks, but only when prices are trending up. (See chart below)

Using the RSI indicator when prices are trending upward.
In this example, the trader has used a simple moving average to determine that prices are trending up. She applies an RSI level of 50 to gauge a likely pullback. In this example, for each time a candle closes in the vicinity or below the RSI level of 50, she opens a buy trade. All trades in this sequence were profitable.

Take sell trades when pullbacks happen, but only when prices are trending downwards. (see chart below)

Here we are using our knowledge of the RSI on a currency pair trending down. As in the previous example, the trader has set an RSI level of 50, as pullback indicator, then simply opens sell positions each time the RSI raises up above the level of 50. Always trade in the direction of the trend, also when using the RSI.

Faling to follow these guidelines can lead to disaster.

Conclusions

The relative Strength Index (RSI) is an extremely powerful indicator, and is on a very short list in the company of MACD, Moving Average, Directional Movement System and a few others.

Some investors have gone so far as to say that the only indicator they need, is the RSI. In clearly range bound markets, characterized by support and resistance levels, you can trade the indicator comfortably, and be quite profitable.

In trending markets, you should trade only the pullbacks, and always in the direction of the trend.

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