Exchange Rates: What Are They And Why Are They Important?

31.05.2019

Whenever we start to look into forex trading and its origins, one of the first things we see is exchange rates. Exchange rates are known these days as the difference in value between the two currencies. For example, if you were to take a currency pair such as GBP/USD, the current exchange rate at the time of writing this is 1/1.31. This means that if you were in the USA and you wanted to buy 1 British Pound Sterling, you would have to pay 1.31 Dollars for it.

Most of us are familiar with exchange rates in terms of going on vacation and swapping currency for our adventures, but how many of us really know why we have exchange rates in the first place? When it comes to learning how to trade on the foreign exchange market, these rates are essential and because of this, it can be a great idea for us to learn more about their origins and importance.

Throughout history, humans have always looked for different ways to exchange one thing for another fairly, and a lot of the time this would have been gold and silver pieces. Coins themselves have been around for thousands of years with people giving other people gold in exchange for food, clothes and other services. Logically you would assume that the whole world should have one universal currency, but this has never been the case. The main reason for this is that different parts of the world are gifted with different volumes of gold and other precious metals. We all know that gold is mined from the ground, and it stands to reason that there are hotspots for gold around the world, where others are sparse. The reason why gold is valued differently in different places is due to supply and demand.

Let’s think about a scenario:

There are three people in a group, looking to exchange apples between themselves. Person 1 has 20 apples, Person 2 has 5 apples, and Person 3 has 1 apple. If someone asked Person 1 for an apple, they would gladly give it for a lower price because they still have lots of apples left. Person 2 will give the apple for a higher price because they only have 5, and Person 3 would need a large sum of money to convince them to part with their only apple.

In this scenario, we can replace people with countries, and apples with gold. Parts of the world who have a lot of gold will have a lower exchange value than those who have less.

Now we can bring this into the current day, and we can now see why exchange rates exist and why people spend time trading currency on the foreign exchange market. In 1935 the USA set a specific value for 1 ounce of gold, and this value was set at $35. Most countries after the second world war, therefore, set their own currency values in relation to the dollar and this is where the differences built up, and the idea of trading currency really took off. Throughout the years, things have changed due to historical and political events, and by the ’70s the dollar didn’t stand for a specific volume of gold any longer. However, as things we already well established around the world, currencies still continue to fluctuate to this day.

In 2019, we can use the foreign exchange market to track the exchange rates of currencies and this is a wonderful world for traders to enter into in the New Year. If you want to learn more about forex trading and start working with exchange rates yourself, you can take our Free Course or Pro Course to learn some key trading skills.

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