Lots, lot size and leverage are concepts used in Forex trading that can be difficult to grasp for those just starting a trading account.
A lot in Forex trading represents how much of a currency you are trading, and it represents the size of the trade (position) being opened. In the stock market, a trader will buy a specific number of shares as this represents the volume of the trade. On the options market, it is contracts that are purchased.
In the currency market, we buy lots, where the lot size is merely the total contract value that a trader has to invest to control that amount of currency.
Types of Trading Lots
Whenever you place a trade, you have the option of choosing the lot size. In order to place trades with high amounts of lots, you will need the corresponding balance in your account to make the trade. We classify lots into three main categories:
A micro lot is equivalent to $1,000 or 1,000 units of the base currency and 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.
Lot size value in EUR/USD
- 1 Micro Lot = $0.10 per Pip
- 1 Mini Lot = $1.00 per Pip
- 1 Standard Lot = $10.00 per Pip
Trading Volume 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 earn if the trade goes in your favor, and how much you would lose should the trade go against you.
For effective risk management, you 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.
How To Calculate Portion Size
Once we have the above parameters then we use the following formula:
Assuming that you are trading with a $10,000 account balance, and you have a 40 pip stop-loss, the position size is calculated as follows to only risk 2% of your account balance.
This mean that 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 a 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 which enables traders to artificially inflate the size of the trade and resulting profit. But, leverage is a double-edged sword it can also amplify your potential loss from a trade.
By using leverage, you are effectively borrowing the extra capital needed from a 3rd party liquidity provider. 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. With this leverage and if you have the margin available, you are now able to open a trade with meaningful trade size.
Forex brokers can offer a wide range of leverage between 1:10 and as high as 1:1000. Starting in 2017 European regulators started limiting the leverage brokers could offer their clients. At the time of writing, there are no restrictions in South Africa.