What is a Lot and Lot Size in Forex Trading? How can I decide lot sizes when I execute my trades?
I’ll try to explain all as much as I can. One of the best advantageous aspects of forex markets is leverage, but the main factor that affects profits and losses is lot size. So, in order to survive large losses in your trades, you need to know what lot means and how you should adjust your lot size.
Basically, lot means size or volume of your trades in Forex. In other words, size of trades you open in the Forex Market is determined by lot. So if you want to learn how many orders you can open and how much margin you need for those orders, you need to know the methods to calculate lots.
In the past, Forex was only traded in specific amounts called lots, or basically the number of currency units you will buy or sell.
The standard size for a lot is 100,000 units of currency. There are also mini, micro, and nano lot sizes that are 10,000, 1,000, and 100 units respectively.
How Much is 1 Lot?
In Forex, 1 standard lot refers to volume of 100,000 units. So when you buy 1 lot of a forex pair, that means you purchased 100,000 units from the base currency (the first currency appearing in a forex pair).
Let’s assume you want to buy EUR/USD and the EUR/USD exchange rate is 1.20. When you buy 1 lot of EUR/USD you will be making $120,000 worth of purchase. If you are using leverage on your broker, you don’t need to have $120,000. With 1:100 leverage, you will only need $1,200 ($120,000 / 100 = $1,200) in order to be able to execute the order. When the leverage goes higher, margin you need to open the trade goes lower. For example, if you are using 1:500 leverage, you need only $240 ($120,000 / 500 = $240) to buy 1 standard lot of EUR/USD.
For 1 standard lot, worth of 1 pip is $10, if USD is on the counter currency in that pair. Thus, if EUR/USD moves upwards for 100 pips after you buy, you are going to make $1,000 of profit.
Traders determine the volume of their trades based on their own risk perception, because bigger lot means bigger profit/loss from the trades. By the way, it is possible to open trades under 1 lot using mini lot, micro lot and nano lot.
As you may already know, the change in currency value relative to another is measured in “pips,” which is a very, very small percentage of a unit of currency’s value.
To take advantage of this minute change in value, you need to trade large amounts of a particular currency in order to see any significant profit or loss.
Types of Lot
Mini Lot
If you are new in forex trading, I strongly recommend you to use mini, micro or nano lots to avoid big losses. Mini lot is equal to 10% of standard lot (100,000 x 0.10 = 10.000 units). Thus, when you open 0.10 lot, you will trade 1 mini lot. Every mini lot worth of 1 pip for EUR/USD is $1.
Micro Lot
Micro lot is equal to 1% of standard lot (100,000 x 0.01 = 1,000 units). When you trade 0.01 lot of EUR/USD, you buy or sell 1,000 units of EUR/USD. Every micro lot worth of 1 pip for EUR/USD is $0.10.
Nano Lot
Nano lot, also called
cent lot by some forex brokers, is equal to either 100 or 10 units. In some forex brokers, nano lot refers to 10 units while in some other brokers, it may refer to 100 units. Nano lot is not offered by many forex brokers. Only few brokers offer this option as an account type such as FXTM and XM. Nano lot is the safest way to trade, if you are a novice trader or if you are testing a new trading strategy. You can go through the learning process with much smaller risk and loss. Besides, if you bought a new expert advisor or are trying a new trading strategy, I recommend you to use nano lot for the first few weeks so that you won’t suffer big losses.
How to Calculate Lot Sizes of Other Commodities
Remember, 1 standard lot means 100,000 units for any currency. But what does 1 lot mean for commodities like gold, silver or oil?
1 lot of Gold or XAU/USD is equal to 100 ounce and 1 lot of Silver is equal to 5,000 ounce. And for the Crude Oil or Brent Oil, 1 lot is equal to 100 barrel. Also, 1 lot of Natural Gas makes 100,000 cubic meters. Those numbers are the industry standards, but may change among brokers. So endeavor to know your broker's standard before you execute a trade on commodities.
A Practical Approach to Lot and Lot Sizes
Let’s assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value.
In cases where the US Dollar is not quoted first, the formula is slightly different.
Your broker may have a different approach to calculating pip values relative to lot size, but whichever way they do it, they’ll be able to tell you what the pip value is for the currency you are trading as at that particular time.
As the market moves, so will the pip value depending on what currency you are currently trading.
What is Leverage?
Leverage involves borrowing a certain amount of the money needed to invest in something.
In the case of forex, that money is somewhat borrowed from a broker.
Forex market offers high leverage in the sense that for an initial margin requirement, a trader can build up, and control a huge amount of money.
You are probably wondering how a small investor like yourself can trade such large amounts of money. Think of your broker as a bank who basically fronts you $100,000 to buy currencies. All the bank asks from you is that you give it $1,000 as a good faith deposit, which it will hold for you but not necessarily keep. Sounds too good to be true? This is how forex trading using leverage works.
The amount of leverage you use will depend on your broker and what you feel comfortable with.
Typically, the broker will require a trade deposit, also known as “
account margin” or “
initial margin”. Once you have deposited your money you will then be able to trade. The broker will also specify how much they require per position (lot) traded.
For example, if the allowed leverage is 100:1 (or 1% of position required), and you wanted to trade a position worth $100,000, but you only have $5,000 in your account. No problem as your broker would set aside $1,000 as down payment, or the “margin,” and let you “borrow” the rest.
Of course, any loss or gain will be deducted or added to the remaining cash balance in your account. The minimum security (margin) for each lot will vary from broker to broker.
In the example above, the broker required a one percent margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit on the position.
How Do I Calculate Profit and Loss?
Let’s buy US Dollars and sell Swiss Francs.
Bid-Ask Spread
Remember, when you enter or exit a trade, you are subject to the spread in the bid/ask quote.
When you buy a currency, you will use the offer or
ASK price.
When you sell, you will use the
BID price.
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