Lot in Forex: What is it and how is it calculated?
The forex market is at least five centuries old. Yes, forex trading is an ancient practice with its roots in Amsterdam. As expected, this market has developed its terminologies over the centuries. This, added to the rich culture, makes conducting business simpler and more enjoyable. Anyone looking to understand the market goes through the baby steps that include knowing these terms. Over and above that, keen traders will fashion their trading alongside this unique lingo.
Whether you are an ordinary trader or an expert, a concrete understanding of forex market concepts can be crucial in making money moves. One of the concepts everyone wants to know is calculating lot size.
What does Lot mean in Forex?
This is one of the differences between the stock and forex market. In the stock market, a figure such as 5,000 shares is just that. That’s what you use to sell and buy.
However, things are a little bit different in the forex market. A unique terminology called lot comes up. There are four lot sizes in Forex, each requiring a particular minimum investment.
The first one is the Nano lot, which stands for less than 1,000 units. Being the smallest one, it is understandable why this lot isn’t very popular with brokers.
There is also the Micro Lot which represents 1,000 units. Traders who want to minimize risk, particularly first-timers, prefer the Micro Lot.
Ten times larger as compared to the micro lot, the mini lot comes with 10,000 units. Anyone wishing to trade with this lot must have a decent amount of capital – the forex market can shift by 1000 points even in an hour. This means that for comfortable trading in say dollars, the trader wants to have a couple of thousands in the account.
At the apex is the standard lot with 100,000 units. Because of the magnitude of fluctuation that goes with a point movement, this lot isn’t for the smaller accounts.
Basic Lot Calculation in Forex
While there is a standardized way of looking at lot sizes in the industry, first-time traders often wonder how to know when operating on a loss or profit. Currency pairs may have different lot amounts, but not so for the major currency pairs – NZDUSD, GBPUSD, EURUSD, and AUDUSD.
For these pairs, 1 pip measurement equals a loss or profit of $10.00. In the same sense, 6 pip measurements translate to a $60.00 loss or profit. It could be a loss or profit based on the market movement direction chosen at the start.
Remember this when choosing a lot size
How risky a portfolio is in forex trading depends on the lot size picked. Therefore, the trader should choose the lot size keenly. A higher number of units may be strategic for higher gains, but they also present a risk of bigger losses.
Since trading is defined by winning and losing, one may deplete their trading account balance on a single trade if the risk is too high. A beginner may want to start with smaller lot sizes and slowly build on that as trading skills improve.
There is a simple formula for determining the best lot size:
Amount to risk/risk in pips = pip value
Consider this example. Take $100 as the amount the trader is willing to risk on a EURUSD trade. If the risk or reward is put at 50 pips, it is possible to calculate the pip value. It happens to be at most $2 or two mini lots.
Understanding the meaning of lot in forex is fundamental to successful trading. Just to recap, there are four categories of lots in forex. The number of lots and the lot size determine the position size of a trader. Multiplying the distance of the price movement by the pip value gives the profit or loss of a trade.
Armed with this crucial information, forex trading should be effective. Test this new knowledge on how a lot in forex works by opening a trading account and trading in a real or simulated environment.