A lot size refers to the number of currency units you intend to trade. This lot size directly affects the size of your profits, as well as your losses. Therefore, determining the appropriate lot size is a key component in risk management.
Consider this example – imagine you’re buying cupcakes at your local pastry shop. These cupcakes come in boxes containing half a dozen cupcakes. Assuming the shop does not sell single cupcakes, this box of six is the standard lot size of cupcakes.
The forex market works in the same way. It is not possible to buy one unit of currency. You can only buy it in lots, and the standard lot usually contains 100,000 units of currency. However, it is possible to buy smaller lots effectively named mini, micro, and nano lots.
Classification of lot sizes
As aforementioned, currencies are divided into standard, mini, micro, and nano lots in the forex market. To better understand these lot sizes, you need to understand the concept of pips. A pip is the smallest unit of change of a currency pair’s price.
For pairs involving the Japanese yen, their prices are quoted in 2 or 3 decimal places. In these, the second decimal place is a full pip, while the third is a fraction of a pip, usually called a pipette. For all other currency pairs that don’t include the JPY, their prices are quoted to 4 or 5 decimal places. For these, the 4th decimal place is the whole pip while the 5th is the pipette.
For example, if you’re trading the EURJPY pair and its price is quoted as 132.668, and you sell it at 132.879, you’ve recorded a profit of 21.1 pips. Similarly, if you were trading the EURUSD pair instead, and you bought it at 1.16517 and sold it at 1.16909, you’ll have recorded a profit of 39.2 pips.
|Lot size||Unit||Volume||Value per pip|
With this in mind, we can summarize lot sizes in the table above.
In forex, a standard lot refers to 100,000 units of a base currency. Thus, if you’re trading the EURUSD pair with one standard lot, you’re buying or selling 100,000 units of EUR. For instance, let’s assume you buy one standard lot of the pair at 1.16500. The price moves to 1.16700, at which point you decide to sell your holdings.
At that point, you stand to make a profit of 20 pips. We established that a single pip movement is worth $10 for a standard lot from our lot sizes table. Therefore, this trade yielded a profit of 20* $10 = $200.
In the FX market, a mini lot comprises 10,000 units of a base currency. Further, each pip movement carries a value of $1. Let’s say you bought a mini lot of the EURUSD pair at 1.16500, and the price fell to 1.16300. If you exit your trade at this point, you will have suffered a loss of 1.16500 – 1.16300 = 20 pips. As aforementioned, each pip in a mini lot carries a $1 value. Therefore, your total loss for this trade is $20.
A micro lot consists of 1,000 units of a currency. This means that it is 0.01 of a standard lot. For example, say you bought one mini lot of the EURAUD at 1.55500. After a few hours, the pair’s price climbs to 1.55800. This means that if you choose to sell at this point, you stand to make a profit of (1.55800 – 1.55500) = 30 pips.
From our lot sizes table, we established that each pip movement in a micro lot equals $0.10. Therefore, this means that from the EURAUD trade, you made 30*$0.1 = $3.
In forex, a nano lot comprises 100 currency units. This means it is 0.001 of a standard lot. If you’re a novice trader who’s trying out the forex market for the first time, it is advisable for you to start trading in nano lots. This will allow you to familiarize yourself with live trading without taking on too much risk. However, only a handful of brokerages offer customers nano lots, so you need to do your due diligence before choosing your broker.
Let’s look at an example. Assume you’re trading the EURAUD pair. You enter your long trade at 1.55500 AUD. Unfortunately, the market dips and the price drops to 1.55000 AUD. Afraid to make any further losses, you choose to exit the trade at this point. This would mean you’ve made a loss of 1.55500 – 1.55000 = 50 pips. Since each pip is worth $0.01, your total loss translates to 50*$0.01 = $0.5.
Why do lot sizes matter?
The forex market is marked by extreme risk and several opportunities to make money. Even for the most experienced traders, every once in a while, they find themselves on the wrong side of the market, which drives them to losses. For this reason, risk management is a vital factor to consider before placing any trades.
Lot sizes help you do just that – manage your risk. By limiting the position size, you control the amount of money you stand to lose if the market goes against you. As a rule of thumb, you should never risk more than 3% of your total account balance on a single trade.
There are several lot size calculators available online. All you need to do is key in your account balance, the maximum risk you’re willing to take and the position of your stop loss, and the calculator will determine the most appropriate lot size for you to trade in.
A lot size is the number of currency units you’re willing to trade with. These lots are divided into standard, mini, micro and nano lots. A bigger lot size translates to bigger profits, but also increased risk. For this reason, determining your lot size is a key step in risk management.