Lot size in Forex is as important as having a reliable Forex trading strategy. Experienced traders know the importance of lot size in Forex trading. However, most beginners and novices don’t know about lot size and its importance.
Lot size in Forex directly influences the risk taken by a Forex trader. Therefore, it is the first concept that new traders should understand. In fact, you cannot achieve success even with a perfect Forex trading strategy if you don’t know how lot size Forex is.
Given the importance of the lot size in Forex trading, we decided to help you understand all about lot size. Our today’s guide will give you the basic definition and everything else you need to know about how to pick the best lot size in Forex.
What is a lot size in Forex?
A lot size Forex refers to a particular amount of any given currency or a set amount of currency that a trader controls. You can define a lot size in simplest words as a unit of measurement in Forex trading that measures the Forex transaction amount. In other words, it denotes the number of currency units a Forex trader buys or sells.
Forex traders trade in specific amounts. These amounts are called lots. Currency pairs are only traded in standard lot sizes. That means traders can get currency units according to standard lot sizes such as 100 units, 1,000 units, and so on. There are four standard lot sizes in Forex;
- Standard lots – A standard lot consists of 100,000 units of a particular base currency. In other words, when you buy a standard lot, it means you buy 100,000 units of the base currency.
- Mini lots – A mini lot is 10% of the standard lot and consists of 10,000 units of the base currency.
- Micro lots – A micro lot is 1% of the standard lot and consists of 1,000 units of the base currency.
- Nano lots – A nano lot is either 0.1% or 0.01% of the standard lot size. It consists of either 10 or 100 units.
Now, you have a basic understanding of common lot sizes in Forex. The next understanding to grasp is how lot sizes influence your profit or loss and risks.
Standard lot size
Standard lots, consisting of 100,000 units, are the most common lot sizes, especially among experienced and big Forex traders. How do you calculate the total amount you have to pay for a standard lot size in Forex? You can better understand it through an example. Suppose that you want to buy a standard lot of EUR/USD. The exchange rate is 1.80. It means you have to pay USD1.80 for one EUR. So, you can purchase a standard lot of EUR/USD at $180,000.
Furthermore, the bottom line of traders is heavily influenced by even minute price fluctuations or pips. Pips are the units of measurement that indicate the change in the value of a currency as compared to another currency in the pair. When using standard lot size in Forex trading, one pip movement up or down brings a change of $10.
Using the previous example, $180,000 might be a small amount for big players in the Forex market. Although gains are high as 1 pip movement in favor means $10 profit, losses are also significant. But, big players might be able to bear losses in case of adverse market movements. However, it isn’t a good idea for beginners to start Forex trading using Standard lot. Why so? Because of the high capital investment and risk level also increases when the invested amount is high.
Mini lot size
As we already know, the mini lot size in Forex is 10% of the standard lot size and contains 10,000 units. It is also a popular lot size in Forex trading, especially for traders who prefer not to use leverage. How do you calculate the total amount you have to pay for a mini lot size in Forex? Again, you can better understand it through an example. Suppose that you want to buy a mini lot of EUR/USD. The exchange rate is 1.80. It means you have to pay USD1.80 for one EUR. So, you can purchase a standard lot of EUR/USD at $18,000.
Is mini lot size suitable for beginners? Perhaps, you are letting yourself be tricked by the term “mini”. It is still a large amount and therefore, not a good size for inexperienced players.
Micro lot size
The micro lot size is the next that consists of 1,000 units. It is the best size for beginners to get a sense of the forex market and gain some experience. How do you calculate the total amount you have to pay for a micro lot size in Forex? Let’s try to understand using an example. Suppose that you want to buy a micro lot of EUR/USD. The exchange rate is 1.80. It means you have to pay USD1.80 for one EUR. So, you can purchase a micro lot of EUR/USD at $1800. Thus, it enables traders to practice Forex trading without risking too much money on risk.
Nano lot size
The nano lot size is the smallest lot size in Forex trading consisting of just 100 units of currency. It is too small and therefore, doesn’t offer any considerable gains.
How to pick the best lot size in Forex trading?
Now, it is time to understand how to pick the best lot size in Forex trading. There are several ways to do it. However, the best approach is to determine your risk and choose lot size accordingly. For example, you can calculate lot size according to 1%, 3%, or whatever rule of your choice. It means your risk will be just 1% of your capital in case of adverse market movement. For instance, if your capital is $10,000, you should not risk more than $100. So, lot size Forex is important because it boosts profits at one end but also increases risks on the other end.
Apart from risk, there are other factors that also play a key role in picking the best lot size in Forex. These factors include;
- Your total capital for trading
- Number of pips you are willing to risk or stop-loss level
- Pip value of the currency pair
So, there are four key factors to consider. Now, let’s divide the overall process into steps for better comprehension.
Steps to pick the best lot size in Forex
Here are the steps you can follow to choose the best lot size for trading.
1. Determine risk percentage
The first and the most important factor is risk. Therefore, it is the first step to determine your risk percentage. You can follow any rule according to your risk-tolerance appetite. However, the general rule is that you should not risk more than 5% of your total capital. Every percentage below 5 is fine.
Stop-losses are an integral part of trading as they limit your losses. In Forex trading, a carefully decided stop-loss level also helps minimize your losses. In order to pick the best lot size in Forex, you should determine your stop-loss carefully. That means you have to figure out when to exit the trade in case of unfavorable price movement. In other words, determine the number of pips you are willing to lose.
3. Calculate cost per pip
Step 3 is a little bit complex as you have to do some maths. Therefore, it is better to understand it through an example. Suppose that your initial capital is $5,000, you are willing to take 1% risk, and choose stop-loss after 10 pips. In this case, your best lot size will be;
Your trade risk = $5,000 × 1% = $50
Your trade risk: stop loss in pips = $50: 10 = $5
Cost per pip = $5 ÷ 0.0001 = 50,000
4. Calculate position size
Position size is important in Forex trading. It should neither be too big nor too small. Why so? Because you don’t need to risk too much by choosing a large position size. Similarly, you have to take a reasonable position size because the too small size will give insignificant profit. So, how can you calculate the best position size?
To calculate the best position size, it is important to understand that you are taking two types of risks. The first one is capital risk and the second is trade risk. You have to account for both risks in order to pick the best position size. You can calculate it using the following formula;
Lot traded = The amount at risk ÷ (pips at risk × pip value)
Got it? If not then try to understand it now because we are going to explain it using an example. Let’s take the same example again. You have $5,000 capital and choose a 1 % risk level. Your amount at risk is $50. You decide a stop-loss below 10 pips and it indicates your trade risk is $100. Now suppose that you decide to choose a Mini lot size for trading that carries a pip value of $1. Put these figures into the formula;
Lots traded = $100 ÷ (10 × $1) = 10 lots
So, you have 10 Mini lots to trade. So, you can choose to trade with 10 Mini lots or go for a Standard lot size because 10 Mini lots are equal to one standard lot. That’s pretty simple. But what if you get an answer like 9.1? Then you will pick 9 Mini lots and 1 Micro lot for trading.
Lot size in Forex trading is very crucial for successful trading. There are four types of lot sizes in Forex – Standard, Mini, Micro, and Nano. A Standard lot size involves significant capital and therefore huge risk is also there. It best suits experienced Forex traders. Whereas, Mini and Micro lot sizes better suit inexperienced traders. They can gain experience and enhance trading skills without risking too much money.
Furthermore, successful Forex trading requires you to pick the best lot size. Although it requires a lot of effort, you have to do it. It allows you to determine your position size according to your risk-taking appetite. In short, picking the best lot size in Forex trading helps you manage risks in the best possible way.