If you’ve ever tried to trade Forex, then you’ve encountered lots. Unfortunately, most beginners at trading Forex don’t understand the purpose and meaning of a lot.
In this article, we’ll simplify the different characteristics of Forex lots, including the following:
- What is a lot in Forex trading?
- Understanding Forex lot size
- Understanding leverage in relation to lots
What Is a Lot in Forex Trading?
When we refer to a lot in Forex trading, we’re discussing a standardized form of measurement. Another essential term is the word “pip,” which refers to a minute amount of change in the value of currency units or a currency pair.
Since Forex brokers and traders alike both rely on pips, trading on single currency units isn’t viable. To simplify the process, the Forex market uses lots that are pre-divided into batches of a certain size.
What Are the Different Lot Sizes?
Now that you know the definition of a lot in Forex trade, let’s take a closer look at how many units make up each lot size.
The nano lot size is the smallest of any lot. At the equivalent of 100 currency units, nano lots are one-tenth the size of micro lots. They’re a reasonably commonly traded lot size among beginner traders or people with low leverage. Since the lots are so much smaller, they have two main advantages, namely:
- You can open an account with less money (often as little as $10)
- The risks are much lower since the pip changes are one-thousandth that of a standard lot.
The micro lot is equivalent to 1,000 units of currency, making it the second-smallest lot size. As the nano lot size is one-tenth that of the micro lot, micro lots are one-tenth the size of a mini lot.
This is commonly the lowest lot size offered by Forex brokers, and you’re likely to encounter it at around 99% of brokers.
With an equivalent value of 10,000 currency units, mini lots are a tenth the size of standard lots. This makes them the second largest lot size and a convenient stepping stone for traders slowly graduating to larger lot sizes.
The standard lot size when you trade Forex is equivalent to 100,000 units of currency. Whether you look at national or international regulations, the standard lots remain the same. You may not see the nano lot regularly, but most brokers offer the standard lot size, as well as micro and mini lots.
How Do Lots Work: Practical Examples
Now that you understand the meaning and value of Forex lots, let’s explore some practical examples that help put things in perspective.
Standard Lot: Suppose you’re trading on the GBP/USD currency pair. The current exchange rate is $1.5000, meaning you’d need 150,000 base currency units (US Dollars) to buy 100,000 Great Britain Pounds.
Mini Lot: Let’s stick to the same scenario and exchange rate, but consider that the mini lot size is one-tenth that of a standard lot. To get 10,000 units of GBP, you’d have to spend 15,000 USD currency units.
Micro Lot: This scenario would have a much lower transaction size with the same parameters as before, even though the currency value hasn’t changed. That’s because a micro lot is one-tenth the size of a mini lot and one-hundredth the size of a standard lot. To get 1,000 units of GBP, you’d have to spend 1,500 base currency units.
Nano Lot: At one-thousandth the size of a standard lot, one-hundredth the size of a mini lot, and one-tenth that of a micro lot, the nano lot offers the smallest lot size. The principle remains the same, albeit on a smaller scale. To get 100 GBP, you’d have to pay 150 of the base currency units.
How Can You Trade Forex Effectively if Lots Are So Big?
When they start trading Forex, many traders struggle to comprehend how they can buy lots of 100,000 units when they can’t possibly afford to. The key to understanding this aspect of your trading account is leverage.
Leverage allows you to spend more money than you currently have at your disposal. Essentially, it’s a short-term loan from your Forex brokers that lasts only for the time that the transaction is open.
The more leverage you have, the higher your position size can be on any particular transaction. You can make significant profit by trading at higher leverage, but it also comes with a high-risk level.
As with any type of loan, your broker may require some kind of collateral. In the case of your Forex trading account, that collateral is known as a margin. The margin consists of the real account funding currency that you’ve deposited into your trading account.
That trading capital is essentially in trust with the broker. Once you’ve placed this margin in trust, you can proceed to win or lose money.
For different currency pairs, your broker may require higher or lower margins. It’s worth noting that the margin required can vary significantly depending on your location and experience levels.
As an example, here are a few common leverage types and what they mean:
- 100:1 leverage – The broker commits 100 USD for each one you commit
- 50:1 leverage – The broker commits 50 USD for each one you commit
- 5:1 leverage – The broker commits five USD for each one you commit
How Do You Calculate the Lot Size in Forex Trading?
With most trading platforms, you’ll never need to calculate the lot size. The platform typically shows you all available options whenever you make a trade.
It’s easy to calculate the position size based on the lot size and how many lots you purchase.
How to Calculate Current Pip Value
The pip works alongside the lot, so you need both values when you’re trying to calculate the current pip value. Fortunately, it’s a fairly straightforward calculation.
Simply divide one pip by the currency pair’s most recent market value. Then, multiply the resulting figure by your lot size. This will give you the current pip value.
For our example, let’s assume that you’re trading the EUR/USD currency pair, and the current price is 1.6000. You’re trading a standard lot of 100,000 units. That would give you the following formula for calculating the pip value:
- (One pip ÷ market price) x lot size
- (0.0001 ÷ 1.6000) x 100,000 units
- = 0,0000625 x 100,000
- = 6.25
In other words, for every single pip movement, you’ll either lose or gain 6.25 Euros.
Choosing a Forex Lot Size When Trading
The key to deciding the lot size you want to trade with is deciding how much you’re willing to risk. The larger the lot is, the more money or leverage you’ll need.
Of course, it also means a magnification of every pip movement. If you don’t mind a high-risk level with the potential of high reward, then standard lot sizes may work well for you.
If you prefer keeping the risks low, even if that means lower potential reward, then you may prefer a micro lot or nano lot. But how does that affect a single pip value?
If you’re working with the EUR/USD currency pair, then the value of a single pip at $0.0001 will be, approximately, as follows:
- Standard lot – $10
- Mini lot – $1
- Micro lot – $0.1
- Nano lot – $0.01
As mentioned earlier, higher leverage can lead to a more significant profit margin, but they also have an increased risk of loss. So, it’s best to choose a lot size that you’re comfortable with. You can always work your way up to a larger lot later on.
We hope this article has helped you to cultivate a more detailed understanding of the lot in Forex. As a reminder, they’re a standardized set of measurements allowing you to understand how many currency units you’re trading.
From the nano lot to the standard lot, they either directly or indirectly affect every aspect of Forex trade.
They can affect how many trades you can make since you can make more trades with the same account capital using smaller lot sizes. You need them to help calculate the profit earned from any given trade.
In the end, every single aspect of your trading experience hinges on how much risk you’re willing to take and how that translates to lot sizes. Fortunately, they’re easy to understand, and most brokers offer calculation services built into the trading platforms.
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