One of the basic terms that you are sure to come across time and time again in forex trading is “a lot.” In this guide, we’ll take a look in detail at what exactly a lot is in forex trading.
What is a forex lot?
Forex is commonly traded in lots, which are essentially the number of currency units you can buy or sell.
A “lot” is a unit of measurement for a transaction amount.
When you place orders on your trading platform, they are placed in lots.
The regular lot size is 100,000 units of currency, but there are now mini and micro lot sizes of 10,000 and 1,000 units, respectively. We’ll go over each one in more detail later.
As you might be aware, the change in a currency’s value compared to another is calculated in “pips,” which is a small percentage of the value of a unit of currency. We’ll discuss how pips affect lot sizes later.
Lot Size Matters
Picking the ideal lot size with a tool like risk management with the desired output will help you decide the best lot size based on your current trading account capital. Whether you’re trading on a demo account or trading live, and it can also help you understand how much you want to risk.
The size of your trading lot directly affects how much a market change affects your accounts. A 100-pip move on a small trade, for example, would not be felt nearly as much as the same 100-pip move on a larger trade.
Your broker may use a different method for measuring pip values relative to lot size, but they will tell you what the pip value is for the currency you are trading at the time.
In other words, they do all of the math for you!
Depending on the currency you are selling, the pip value can change as the market moves.
Ok, let’s move to types of lots.
1. Standard Lot
A standard lot is one with 100,000 units. If you’re dealing in dollars, that’s a $100,000 trade. Trading with this position size means that the trader’s account value can fluctuate by $10 with every pip move.
For a trader with only $2,000 in their account, a 20-pip move will result in a 10% change in account balance. As a result, the majority of retail traders with limited accounts do not deal in standard lots.
The majority of forex traders you will come across trade mini lots or micro lots.
It might not feel much, but keeping your lot size within a reasonable limit to your account size will help you protect your trading capital in the long run.
2. Mini Lot
A mini lot comprises of 10,000 units of your account currency. If you use a dollar-based account and trade a dollar-based pair, each pip in your trade is worth approximately $1.00. If you are a beginner and want to start trading with mini lots, make sure you have fair trading capital.
Although $1.00 per pip will seem to be a small sum, the market in forex trading may shift 100 pips in a day, and sometimes even in an hour. If the market moves against you, this equates to a $100 loss.
It is entirely up to you to determine your ultimate risk tolerance. To trade a mini lot, you should start with at least $1,000, so you do not blow up your whole account.
3. Micro Lot
Most brokers offer micro lots as the smallest tradeable Lot. A micro lot has 1,000 units of the currency used to finance your account. If you finance your account in U.S. dollars, a micro lot is $1,000 worth of the base currency you want to trade. In the case of a dollar-based pair, 1 pip is equal to 10 cents. 2 Micro lots are ideal for beginners who want to keep risk to a minimum when learning to trade.
How lot size affect the pip value?
As mentioned earlier, a PIP is the smallest price change in currency trading.
For instance, if EUR/USD is trading at 1.1980 and prices change to 1.1985, we can say it has moved 5 pips.
Pairs with JPY have a different approach. For example, if USD/JPY is trading at 115.20 and prices change to 115.23, we can say it has moved 3 pips.
The aim of using PIP values per Lot is to decide how much money we gain or lose per PIP, taking into account the amount of currency that we want to trade with.
The pip value per lot size formula is:
PIP value = Number of PIPS/Exchange rate x Lot size
The first part of the calculation is a straightforward currency conversion; we divide our PIP value by the current exchange rate based on the pair we trade. This way, we will determine how much a PIP is worth in terms of the currency we are trading.
The first part of the formula is doing a simple currency conversion; we divide our PIP value according to the pair we trade by the current exchange rate. This way, we know how much that PIP worth in terms of the currency we are trading is.
The second step is multiplying the result by the lot size we are trading with (standard, micro, or mini) to understand the effect of the previous number we calculated on the total number of currency units we are trading.
Let’s assume we will be using a standard lot size (100,000 units). We will now calculate some examples to see how it affects the pip value.
USD/CHF at an exchange rate of 1.4500: (.0001 / 1.4500) x 100,000 = $6.89 per pip
In cases where the U.S. dollar is not quoted first, the formula varies.
EUR/USD at an exchange rate of 1.1900: (.0001 / 1.1900) X 100,000 = 8.40 x 1.1900 = $9.99 approximately $10.
Bottom line
Knowing the various Lot sizes available and how to measure the pip value will help you create effective risk management strategies while trading.