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Definition of a Lot in Forex
April 28, 2014 by Adam posted in • No Comments
What is a Lot?
A Forex lot is a trading term used to describe the size of a trading position in Forex with reference to a standard of 100,000 units of the base currency.
The benchmark for forex trades is 100,000 units of the base currency, and since this trade size is the standard against which other trade sizes are measured, this is referred to as one Standard Lot.
The Standard Lot is therefore assigned a value of 1.0, and it is equivalent to a position size of 100,000 units of the base currency in which the trader’s account is held.
Trade sizes can be a lot more or a lot less than a standard lot. This is why there are subdivisions of the Standard Lot as follows:
a) One-tenths of the Standard Lot, known as the Mini Lot.
This is equivalent to a position size of 10,000 units of the base currency of the account, with a minimum lot size of 0.1 lots. Mini lot measurements therefore start from 0.1 lots to 0.99 lots.
b) One-hundredths of a Standard Lot, known as the Micro Lot. This is equivalent to a position size of 1,000 units of the base currency of the account, with a lot size of 0.01 lots.
Micro lot measurements start from 0.01 lots to 0.099 lots, or 0.1 mini lots to 0.99 mini lots.
c) Lately, some brokers have come up with position sizes that are even smaller than a micro lot, and they go by several names.
However, these are not standardized and tend to differ from one broker to another. So we will stick with the standard definitions of the Standard Lot, Mini Lot and Micro Lot.
All other trade sizes are expressed in multiples of the Standard Lot, or subdivisions of the Lot/multiples of the Micro Lot or Mini Lot.
The Financial Worth of Forex Lots
Lots in forex are used to assign a measurement to the trade volume of a forex trade position.
Considering that the value of a trade position as well as the movement of the currency pair in pips is what determines the level of profit or loss after a forex trade, what is the monetary value of the forex lot? We will assume that the base currency is US Dollars.
a) Standard Lots are worth $10 per pip on currency pairs that do not include the Japanese Yen This is derived by multiplying the position size of a Standard Lot ($100,000) by 1 pip (0.0001 points).
100,000 X 0.0001 = $10.
b) Mini-lots are worth $1 per pip (10,000 X 0.0001)
c) Micro-lots are worth $0.1 (10 cents) per pip, as 1,000 X 0.0001 = 0.1
All other measurements of the value of a pip can be calculated using these formulae.
So a trade which uses 0.55 lots will be worth 55,000 X 0.0001 = $5.50 per pip.
Why Forex Lots are Important
The value of the forex lot applied to a trade will have a bearing on the risk profile for the account. The risk to an account is a function of the account size, stop loss, currency traded, risk percentage applied and the Lot size. This is shown in this demonstration using a forex position size calculator.
A trader has $2,500 in forex capital, wants to use 3% risk and a stop loss of 50 pips.
Forex commission calculation for micro lot
What lot size should be use to keep his account from being exposed to too much risk? We refer to a position size calculator to do the Maths for us:
We can see clearly that the trader can only use a maximum of 15 micro lots (0.15 lots) for this trade.
If the trader intends to take more than one trade, then the lot size must be divided by the number of trades to come up with a new lot size measurement which will stick to the limits of risk.
We can see that the forex lot is an integral part of what traders must consider before putting on a trade.
Traders must use lot sizes that conform to acceptable risk limits. Lot sizes will therefore have to be considered when choosing a broker, when funding the account and definitely before putting on a trade position.
Broker choice is important as some brokers may only permit certain trade sizes on their platform.
Why to Trade Micro Lots - Earn your right to make profits first!
If a trader with $1,000 chooses a platform in which mini lots are the minimum position size that can be traded, then the account will be highly subject to risk and could suffer a margin call.
Sufficient funds will also be needed to assume certain levels of forex position sizing.
From our calculator, we will see that if the same trader we used in our example had $6,000 to trade, then higher position sizes could be used.
Understanding the forex lot is key to trading success.
Learn it, use it and profit with it.