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Working Principle of a compass

In ancient times, the sailors who used a magnetic compass to navigate, believed that a group of stars or a mysterious range of iron capped mountains in the north regulate its working. In China, the magnetized iron found in the lodestone, a naturally occurring magnetic ore was used to make a floating compass in the 12th century. A piece of magnetized iron placed on a wooden splinter and floated in a bowl of water would itself swing to north-south direction. A small pocket compass works on the same principle as the first crude compass: instead of a lodestone and a wood splinter, it has magnetized needle that swings on a pivot to indicate north.The compass works because earth itself is a huge magnet. Its magnetic poles are oval areas about 2100 Km from the geographic north and south poles. The magnetic North Pole is in Canada and the magnetic South Pole is near Antarctica. Irregular lines of force connect the magnetic poles and the compass needle simply aligns itself with these lines of force.

Web references :

Magnetic Compass
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The Magnetic Compass National Maritime Museum.