What is a lot in forex trading?
The term “lot” is one of the key terms in forex trading.
A lot is a method of determining how many currency units are required for a trade.
A lot is the smallest available trade size that a forex trader can place when trading forex.
What is lot size in forex?
A lot size indicates the number of units of the base currency in a currency pair quotation. Put differently, it is the number of base units that a forex trader will buy and sell. The base currency is the first currency that appears in a currency pair quotation.
The lot size you are trading with has a direct impact on how much a move in the market affects your trading account. A bigger lot may generate big profits, but also big losses. Therefore, your trade volume has an effect on your trading strategies and your management of risk.
Keeping your lot size reasonable relative to the amount available in your trading account will ensure that you will have enough trading capital for future trading.
Take note that some forex brokers show quantity in “lots”, while others show the actual currency units.
There are four main types of lot sizes you will come across when trading in the forex market, namely: standard lot, mini lot, micro lot, and nano lot.
A standard lot corresponds to 100 000 units of the base currency in a quote of currency pairs. Put in other words, 100 000 units = 1 lot.
For example: Assume you want to buy a standard lot (100 000 units) of GBP/USD. The exchange rate is 1.24, meaning you will pay USD1.24 for one British pound. What will happen is that you will purchase £100 000 with $124 000.
However, if your broker authorises you to use leverage you don’t need $124 000. With leverage of 1:100, you will only need $1 240 ($124 000/100 = $1 240) to finalise your order.
A mini lot equals 10% of a standard lot (100 000 x 0.10) = 10 000 units of a base currency. Thus, when you open a trade with a 0.10 lot, you will trade 1 mini lot.
It is a great choice for those forex traders who may want to trade with a lower, or perhaps no leverage at all.
A micro lot is 1% of a standard lot (100 000 x 0.01) = 1 000 units of a base currency. Therefore, when you open a trade with a 0.01 lot, you will trade 1 micro lot.
Micro lots are the smallest tradable lot available to most brokers and are a good starting point for beginners.
A nano lot is 0.1% of a standard lot (100 000 x 0.001) = 100 units of a base currency. Opening trade with a 0.001 lot means you will trade 1 nano lot.
A nano lot also described as a “cent lot” by some forex brokers, comprises 100 currency units. However, some forex brokers use the term to refer to 10 units of a currency.
It is not offered by many forex brokers lately, but if available, it could be a safe starting lot size for a novice trader who wants to try his hand at forex training or for a trader who wants to test a new trading strategy. It is a wise strategy for a beginner trader for the first few weeks of trading, just in order to avoid big losses.
Importance of pip values for lot sizes
Lot sizes matter, because they directly impact and indicate the amount of risk forex traders are taking. A move in the market has an impact on a trader’s trading account and a lot size determines how big that impact is. For instance, a move of 100 pips on a small trade will not have the same effect as the same 100-pip move on a very large trade size.
Therefore, understanding now what a lot size is, we have to focus on pip value calculation in order to determine profits or losses from our forex trading.
Calculation of pip values
A pip is the unit of measurement to indicate the change in value between two currencies. It is usually the last decimal place of a currency pair quote. For instance, if the quote EUR/USD moves from 1.1075 to 1.1077, that is a two-pip movement.
It is a significantly small percentage of a unit of a currency’s value.
The impact of a change in the value of a pip on profits and losses depends on both the currency pair you are trading as well as the currency you funded your trading account with.
Usually, your forex broker or trading platform will do the pip calculations for you. Although, it is a useful process to acquaint yourself with.
The value of a pip can be calculated by dividing 1/10 000 or 0.0001 by the exchange rate, also called the current value of the currency pair. Then multiply that figure by your lot size, which is the number of base units you are trading.
For example, if GBP/USD is currently trading at an exchange rate of 1.2400 and trading with a specific lot size, the pip value will respectively be:
- Standard lot of 100 000 units: The pip value is calculated by (0.0001/1.2400) x 100 000 = 8.0645. This means for every movement of one pip you would lose or gain 8.0645 British pounds.
- Mini lot (10 000 units): The pip value is 0.6667 (0.0001/1.2400) x 10 000, meaning a one pip move would be a profit or loss of 0.6667 of a British pound.
- Micro lot (1 000 units): The pip value is 0.0806 (0.0001/1.2400) x 1 000, implying a one pip move would be a profit or loss of 0.0806 of a British pound.
- Nano lot (100 units): The pip value is 0.0081 (0.0001/1.2400) x 100, which indicates a gain or loss of 0.0081 of a British pound with every movement of one pip.
The value of a pip will differ between currency pairs, because of the variations in exchange rates.
However, if the US dollar is the quote currency, i. e. the second currency in a currency pair quote, the value of a pip is always the same, for instance:
- USD10 for a standard lot of 100 000 units of a currency.
- USD1 for a mini lot of 10 000 units of a currency.
- 10 for a micro lot of 1 000 units of a currency.
- 01 for a nano lot, which is 100 units of a currency.
Words of caution
The value of a pip is important because it affects risk. By not knowing how much a pip is worth, you will not be able to calculate the most effective trade position and you may end up risking too much or too little on a forex trade.
A pip’s value can represent a significant exposure when leverage is utilized.
The lot size directly indicates and impacts the amount of risk a trader is prepared to take.