Lots, lot size and leverage are common words used in Forex trading. But they can be difficult to grasp for those starting a trading career and this is particularly true if you have never traded before.
A trading lot represents how much of a currency you’re trading. A lot sizing in the currency market is our position size.
It’s the same thing as a share in the stock market or a contract in the options market. When you buy stocks, you buy a certain amount of shares. You can buy one share, you can buy 10 shares, and you can buy 1000 shares.
In the currency market, you’re buying lots. So, you’re buying denominations of the currency. A lot size is merely the total contract value that a trader has to invest to control that amount of currency.
Types of Trading Lots
We classify lots into three main categories:
- Micro Lots
- Mini Lots
- Standard Lots
A micro lot is equivalent to $1,000 or 1,000 units of the base currency. It typically represents the smallest position size you can trade with. If you trade one micro lot worth of EUR/USD then each pip movement will be worth $0.1 loss or profit.
A mini lot is equivalent to $10,000 or 10,000 units of the base currency. If you trade one mini lot worth of EUR/USD then each pip movement will be worth $1 loss or profit.
A standard lot is equivalent to $100,000 or 100,000 units of the base currency. In other words, you control $100,000 of buying power.
Some Forex brokers offer Nano lots which are equivalent to $100 or 100 units of the base currency.
What lot sizes are worth in EUR/USD:
- 1 Micro Lot = $0.10 per Pip
- 1 Mini Lot = $1.00 per Pip
- 1 Standard Lot = $10.00 per Pip
Whenever you place a trade, you have the option of choosing the lots size. You will need a certain amount of money in your account to place certain lot sizes.
The Relationship between Lots Trading and Risk
The key to implementing a good risk management strategy is to determine the most appropriate lot size that you’re willing to risk. Using the correct position size will help you control how much you will win if the trade goes in your favor. And how much you would lose should the trade go against you.
For effective risk management, we need to know two things.
- To find the largest position size we can trade, we need to know the account size or our account balance.
- To determine the correct position size, you also need to know the size of your stop loss.
Once we have the above parameters then we use the following formula:
Assuming that you’re trading with a $10,000 account balance and you have a 40 pip stop loss and only risk 2% of your account balance then the position size is calculated as follows:
So, as to only risk 2% of your account balance, you will need to trade 5 mini lots to keep within the limits of a good risk management strategy.
What is Leverage?
The Forex market moves in small increments of 100th of a cent, so to make any significant money we need to magnify the trade size. Leverage is the trade size multiplier used in CFD trading that will enable traders to boost potential profits from a trade.
But, leverage is a double edged sword it can also amplify your potential loss from a trade.
By using leverage, you borrow the extra capital needed from your broker or a 3rd party bank. With this leverage, you are now able to open a trade with meaningful trade size.
How much leverage a trader chooses to use, will impact the margin needed to open the trade. Read more to understand equity and margin when using leverage from this article.
The Forex brokers can offer a wide range of leverage anywhere between 1:10 and as high as 1:1000. Starting in 2017 governments started limiting the amount of leverage brokers could offer their clients. At the time of writing, there are no restrictions in South Africa.