If you wish to trade the forex market, one of the first things you have to learn is the concept of lot size. The concept lies at the center of how you manage the risks involved in trading the forex market, which, in turn, determines your long-term success in the game.
As you will get to realize later in this post, understanding and managing your lot size is more important than how you find your entry and exit points. Even if you have the best edge in the market, without managing your position size well, you will find it difficult to succeed in your trading journey. You will either be taking too much risk — if you trade big lot sizes — which increases the likelihood of blowing your trading account or be wasting your time in the market without meaningful account growth.
Thus, it becomes necessary that we discuss this important concept to help you understand how to manage your trading risks properly. In this post, you will learn the following:
- What lot size means in forex trading
- How lot size affects pip value
- The relationship between lot size and other trading parameters
- The effects of lot size on your profit and loss
- How to choose the right lot size for each trade
What is lot size in forex trading?
In forex trading, lot size is the measure of position size. Unlike the stock where a trader’s position size is measured in the number of shares bought or sold, in the forex trading world, position size is measured in lots. A lot is basically the pre-defined number of currency units you are willing to buy or sell when you enter a trade.
In other words, lot size is about your trading size or trading volume, which determines the number of currency units you are trading. Depending on the number of units involved, lot sizes are categorized into the following:
- Standard lot
- Mini lot
- Micro lot
- Nano lot
A standard lot stands for 100,000 units of the base currency; a mini lot stands for 10,000 units, a micro lot stands for 1,000 units; while a Nano lot stands for 100 units of the base currency. So, if you buy a standard lot of a currency pair, you are buying 100,000 units of the base currency.
As you know, currencies are traded in pairs, as you are automatically selling one currency to buy another. The first written currency in a pair is the base currency, while the other is called the quote currency. When you buy a currency pair, you are buying the base currency, using the quote currency. On the other hand, when you sell a currency pair, you are selling the base currency to buy the quote currency.
So, let’s say you are to buy one standard lot of EUR/USD, and the pair is trading at 1.10000. What this means is that you are buying 100,000 units of the EUR, using 110,000 units of the USD. On the other hand, if you are to sell one standard lot of the EUR/USD, it means you want to sell 100,000 units of the EUR to buy 110,000 units of the USD. Note that there will always be a little difference between the buy and sell units in the quote currency due to the “spread” factor.
Extending our analogy to the mini lot, you would see that buying one mini lot of EUR/USD implies buying 10,000 unit of the EUR with 11,000 units of USD, while selling one mini lot of the pair means selling 10,000 units of the EUR and buying 11,000 units of the USD. The same analogy applies to the micro lot and nano lot.
From our discussion so far, it follows that one mini lot is equivalent to 0.1 Lot (standard lot), while one micro lot is equivalent to 0.01 Lot. In the same vein, one nano lot will be equivalent to 0.001 Lot.
It is important you note that your trade volumes must not be in a single unit of the standard, mini, micro, or nano lot. You can actually trade 2, 3, or more standard lots, mini lots, or micro lots — as your account size (trading capital) allows you. Of course, 2 standard lots means 200,000 units of the base currency, just as 3 micro lots would mean 3,000 units of the base currency.
How lot size affects the pip value
For any given currency pair, the lot size you trades affects the value of each pip you make or lose. As a rule, the bigger the lot size, the bigger the pip value, but why is that? To understand how lot size affects pip value, you need to understand the concept of pip.
A short form for ‘point in percentage’, the pip is a concept used in forex trading to measure the change in the value of a currency pair. It is the standardized unit for measuring price movements, and it is represented by the fourth decimal point (0.0001) in a 4-point currency pair like the EUR/USD or the second decimal point (0.01) in a 2-point currency pair like the USDJPY. So, if EUR/USD moves from 1.1000 to 1.1001, there is a 0.0001 rise in value, which represents one pip. Similarly, if the USDJPY moves from 120.00 to 120.01, there is a 0.01 rise, which is one pip.
Therefore, the pip is considered the smallest price change in a currency pair until most brokers stated adding another decimal point to the currency quotes, making the 4-point pairs now five decimal points (1.10010) and the 2-point pairs three decimal points (120.010). The last point, which is called the pipette, is one-tenth of the pip and is now the smallest unit of price change in a currency pair.
The pip value can be measured in terms of the quote or the base currency in the pair. Most of the time, the value of the pip is calculated in USD for currency pairs containing USD, whether the USD is the quote or the base currency. Even for currency pairs that do not contain USD, brokers often covert the value to USD for easy profit and loss calculation.
Before we proceed to show how the lot size affects the pip value, you should note this: In a currency pair, the quoted price (exchange rate) is the value of the quote currency that exchanges for one unit of the base currency. So, price movement represents a change in value in the quote currency. If the EUR/USD is quoted as 1.1000, it means that 1 EUR exchanges for 1.1000 USD and can be written as a ratio: 1 EUR to 1.1000 USD or 1 EUR / 1.1000 USD.
Now, to show how different lot sizes affect the pip value, we have to calculate the pip value using different lot sizes.
Example 1: USD/JPY = 120.00
Pip value (in base currency) = [change in value in quote currency] X [the exchange rate ratio] X [number of units traded]
- Pip value for standard lot size = [0.01 JPY] X [1 USD/120.00 JPY] X 100,000 = 8.33 USD
- Pip value for mini lot size = [0.01 JPY] X [1 USD/120.00 JPY] X 10,000 = 0.833 USD
- Pip value for micro lot size = [0.01 JPY] X [1 USD/120.00 JPY] X 1,000 = 0.0833 USD
- Pip value for nano lot size = [0.01 JPY] X [1 USD/120.00 JPY] X 100 = 0.00833 USD
Example 2: EUR/USD = 1.1000 (where USD is the quote currency)
Pip value (in base currency) = [change in value in quote currency] X [the exchange rate] X [number of units traded]
Note that the base currency here is the EUR:
- Pip value for standard lot size = [0.0001 USD] X [1 EUR/1.1000 USD] X 100,000 = 9.091 EUR
- Pip value for mini lot size = [0.0001 USD] X [1 EUR/1.1000 USD] X 10,000 = 0.9091 EUR
- Pip value for micro lot size = [0.0001 USD] X [1 EUR/1.1000 USD] X 1,000 = 0.09091 EUR
- Pip value for nano lot size = [0.0001 USD] X [1 EUR/1.1000 USD] X 100 = 0.009091 EUR
To convert the pip value to USD, you divide the EUR value with the exchange rate ratio. Thus, the pip value for the various lot sizes are as follows:
- Pip value for standard lot size = [9.091 EUR] / [1 EUR/1.1000 USD] = 10 USD
- Pip value for mini lot size = [0.9091 EUR] / [1 EUR/1.1000 USD] = 1.0 USD
- Pip value for micro lot size = [0.09091 EUR] / [1 EUR/1.1000 USD] = 0.1 USD (10 cents)
- Pip value for nano lot size = [0.009091 EUR] / [1 EUR/1.1000 USD] = 0.01 USD (1 cent)
Please note that the pip value in USD calculated here is the same for any currency pair where the USD is the quote currency.
A table showing the pip value for various lot sizes in USD/JPY and any currency pair with USD as the quote currency
It is also important to note that the pip value of any lot size varies in currency pairs where the USD is the base currency. Thus, the pip value for 1 Standard lot in USDJPY is different from that of USDCHF and also different from that of USDCAD.
The relationship between lot size and other trading parameters
Now, let’s consider how the lot size is related to other trading parameters, such as leverage, margin, money management, and stop loss.
Lot size vs. leverage
Now that you know what lot size means, let’s see how it relates to leverage. In the world of financial trading, leverage is the amount your broker is ready to lend you so that you can trade bigger lot sizes than your account balance could carry without it. It is expressed as a ratio of the amount lent by the broker to the amount you must provide to trade that lot size, which is referred to as the margin — more on that later.
If a broker offers leverage of 50:1, for example, it means that for each amount you provide, the broker will make it up to 50 times that amount. So, you can use one unit of a currency pair to control 50 units of that pair, and by extension, you can use 2 units to control 100 units (nano lot size), 20 units to control 1,000 units (micro lot size), 200 units to control 10,000 units (mini lot size), and 2,000 units to control 100,000 units (standard lot size). By trading bigger lot sizes, leverage allows you to increase your profits, but it also magnifies your losses by the same factor.
Note that amount of leverage does not have any effect on the value of the lot size itself — a standard lot remains 100,000 units, while a micro lot is still 1,000 units — but it can affect the number of lots you can trade with the balance on your account. With a 50:1 leverage, you can trade a mini lot on a $1,000 account balance, but you cannot trade a standard lot.
You can also look at it the other way round — the number of lots you trade with a particular account size determines the amount of leverage you are using since you must not use the maximum leverage provided by the broker. That is, if you are trading a micro lot with a $500 account, you are automatically using a 2:1 leverage irrespective of the broker’s maximum allowable leverage — be it 50:1 or 100:1. Hence, no matter how much leverage allowed by the broker, you can control how much you use.
Lot size vs. margin
Margin is closely related to leverage, and, hence, its value can be affected by the lot size. Margin can be classified as required, used, or free margin. The Required Margin is the amount of money a trader needs to put down in order to open a specified lot size of a leveraged trade. It can be expressed as a percentage of the total amount the specified lot size is worth or in the actual amount of the margin requirement.
When there are many open trades, the term Used Margin refers to the aggregate of all the Required Margin from all open positions. Free Margin, on the other hand, is the difference between your account Equity and the Used Margin [Equity – Used Margin], so it only comes up when there’s an open position. Also known as usable margin or available margin, Free Margin is the amount available to open new trades or cushion the effects of negative price movements until the trade is stopped out or you get a margin call.
But let’s first focus on the Required Margin, which is derived from the leverage ratio. Required Margin varies with both the leverage and the lot sizes. For a given leverage ratio, the Required Margin percentage is the same, but the actual value of the Required Margin varies with the different lot sizes. The bigger the lot size, the bigger the margin required to trade it, as you can see in the table below.
As we stated earlier, you can control the amount of leverage you use by controlling the amount of lot size you trade irrespective of the broker’s maximum allowable leverage. And from the table above, for a specified lot size, the higher the allowable leverage, the smaller the amount that can be used to carry 1 lot size. So, it follows that for a given account size and lot size, the higher the allowable leverage, the lower the Required/Used Margin, and the larger would be the Free Margin when 1 lot size is open, assuming the profit or loss is at zero.
For example, if you are using a $500 account to open 1 micro lot size with a broker that offers 200:1 leverage, your free margin is $495 ($500 – $5). Here, the used margin is $5 and the equity is still $500 because we’re assuming a zero profit or loss. For a broker that offers a maximum of 20:1 leverage, using the same $500 account size and 1 micro lot and assuming a zero profit or loss, the free margin would be $450 ($500 – $50).
Lot size vs. money management
Money management is all about how you manage your trading account. It is key to your trading success over the long term, and the amount of lot size you trade affects how you manage your trading capital and growth potential.
If you trade larger lot sizes that are too big for your account, you run the risk of blowing your account in no time, as you can lose several consecutive trades no matter how good your trading strategy is. On the other hand, if you trade a very small lot size, your account will remain stagnant. So, you need a good money management plan.
A money management plan always starts with knowing the percentage of your account balance you will risk in a trade. You should risk only 1% 0r 0.5% of your account if you are a newbie. Experienced traders can do 1-2% of their account balance per trade. With the dollar amount of this account risk percentage, you can calculate the right lot size to trade.
Depending on your account size and dollar risk, it may be better to trade in multiples of mini or micro lots than trading the standard lot, as it makes it more flexible to manage your account growth. That is, as your account grows, you increase your trading position size in multiples of mini or micro lots rather than adding a full standard lot.
Lot size vs. stop loss
Of course, lot size affects how much stop loss traders use. Some traders tend to trade bigger lot sizes and use smaller stop loss so as to maintain their preferred account risk amount. However, this is the wrong way to trade because it increases the chances of being stopped out before the trade has the chance to move in the anticipated direction.
It is much better to trade a smaller lot size and use a bigger stop loss. This way, you are giving enough room for the usual price gyrations before the price moves. Moreover, trading a smaller stop loss reduces your potential losses if the price gaps beyond your stop loss level.
What should determine the amount of your stop loss is the structure of the market and volatility, not the number of lot size you intend to trade. In fact, the right approach is to determine a safe place on the chart to place your stop loss, measure the number of pips it will take, and then, use that number to calculate the appropriate lot size for the amount you intend to risk in that trade.
Your lot size affects your profit or loss
By now, it is clear that lot size determines the dollar value of a pip, and price movements (in favor or against your position) are measured in pips. Thus, the lot size you trade surely affects your profit or loss. If you trade big lot sizes, you will make huge profits if the trade is a winner, but if the trade is a loser, your losses are magnified too.
On the flip side, if you trade too little a lot size, you will make small profits or losses in each trade. While this may be fine — at least, it helps preserve your account capital — it may take a lot of time to grow your trading capital. It is, therefore, necessary that you learn how to determine the right lot size for your account level.
How to choose the right lot size to trade
To determine the appropriate lot size for your account balance, you need to know these three things:
- The amount to risk in each trade: First, you need to know the percentage of your account balance you are willing to risk per trade. It is common to use 1% of your account balance. If your account balance is $1,000, for example, 1% is $10. So, you will risk this amount in the next trade.
- The size of your stop loss: Use the volatility in the market and the price structure on your chart to determine a safe place for your stop loss and measure the number of pips. Let’ say it is 50 pips.
- The value of a pip: Each currency pair has its pip value for the standard lot, mini lot, micro lot, and Nano lot. You can use the pip value for any of the lot sizes, but the unit of the lot size you calculate must be in the type you used for the pip value. Let’s use the pip value for EUR/USD mini lot, which is $1.
Your appropriate lot size = Amount at risk / (Pip value x pips at risk)
Your lot size (in mini lots) = $10/ ($1 x 50) = 0.2 mini lot
Converting it to micro lots, it becomes 2 micro lots.
The lot size is a concept in forex trading used in measuring your position size and is defined as the number of currency units you are willing to buy or sell when you enter a trade. It is at the center of your risk management and affects most trading parameters, including the pip value of each currency pair, leverage, margin, money management, stop loss, and profit or loss.