Retail trading is more structured than the forex market as a whole.[citation needed] While forex has been traded since the beginning of financial markets, modern retail trading has only been around since about 1996 . Prior to this time, retail investors were limited in their options for entering the forex market. They could create multiple bank accounts, each one denominated in a different currency, and transfer funds from one account to another in order to profit from fluctuating exchange rate. This was troublesome, however, because the transaction costs incurred were large due to the small quantity of funds being converted relative to the size of the market. This transaction type was at the very bottom of the forex pyramid.
By 1996, new market makers took advantage of developments in web-based technology that made retail forex trading practical. These internet-based market makers would take the other side of retail trader’s trades. The new companies felt that there was enough liquidity in the forex market, and eventually within their own customer base, to guarantee markets under all but the most unusual market conditions. These companies also created online trading platforms that provided a quick and easy way for individuals to buy and sell on the Forex Spot market. In addition, the companies realized that by pooling many retail traders together, they had the size to enter the upper echelons of the forex market, which reduced the size of the spread. As the business grew, the market makers were given better prices, which they then passed on to the customer.
Market makers got around this issue by allowing customers to inflate all movements many times over. In the world of online currency exchange, no transaction actually leads to physical delivery to the client; all positions will eventually be closed. The market makers are therefore able to offer high amounts of leverage. While up to 4:1 leverage is available in equities and 20:1 in Futures, it is common to have 100:1 leverage in currencies; some forex market makers offer up to 400:1. In the typical 100:1 scenario, the client absorbs all risks associated with controlling a position 100 times the capital they are putting up, and, given that the money is only being used for currency exchange and on the market makers’ books, the transaction can proceed.
Current spreads for the most common currency pair, EUR/USD, is typically 3 pips (3/100th of a percent). An equivalent trade using a bank account would most likely be between 200 and 500 pips, while an equivalent trade using cash at an exchange institution would be around 750 – 2500 pips.
Currencies are quoted in pairs i.e. EUR/USD (Euro vs. United States Dollar). Out of convention, the currency quoted first was the stronger currency at the time of inception
