In forex trading, lot size refers to the size of a trade. One lot is 100,000 units of the base currency. It’s a standardized measurement, regardless of what the base currency actually is.
This means that a 1 lot trade of GBPUSD is 100,000 GBP worth of USD. And a 1 lot trade of EURAUD is 100,000 Euros’ worth of Australian dollars.
Lot size & lots in forex trading
It’s easier to use measurements like lots because of the quantities of money involved in forex trading. For example, if the price of a currency changes in your favor by 20 pips, well, 20 pips is only a fifth of a cent. In order to make sure that any gains are worthwhile, forex traders typically trade with relatively large quantities of money (usually on margin).
Therefore, a 1 lot trade of GBPUSD moving in your favor by 20 pips would represent a gain of $200.
You can also use a decimal point with lot sizes. For example, 1.25 lot is 125,000 units of the base currency. A lot size of 0.77 is 77,000 units of the base currency.
Lot size & risk management
Lot sizing is really important because it goes hand in hand with good risk management practices.
Generally speaking, you should never risk more than 1-2% of your account balance per trade.
Let’s say you have an account balance of $10,000. You want to trade 1 lot of gold against the U.S. dollar (XAUUSD).
You enter a buy trade at 1847, with your take profit at 1952. You set a stop loss of 1842.
However, with a 1 lot trade, your trade incurs a $1 loss for every cent that gold decreases in price.
If the price decreases enough to trigger your stop loss, you would lose $500.
You would lose 5% of your account balance, which in terms of standard risk management practices, is too much.
The right way
Using the above example, if you wanted to open a 1 lot trade, then in order not to risk more than 2% of that $10,000 account, you would have to set your stop loss no lower than 1845.
If gold dropped 200 cents from 1847 to 1845 and triggered your stop loss, then this would mean losing $200 – or 2%.
However, if, due to your analysis, you believe that 1845 is too tight for a stop loss and you think 1842 would be more appropriate, then this can mean only one thing: you need to reduce the size of your trade so that the triggering of a stop loss won’t cost you more than 2%.
Halving the lot size to 0.5 would mean a loss of 50 cents for every cent that gold fell in price. So if the price fell 500 cents to the stop loss of 1842, that would mean a loss of $250. Which is still a bit too much.
$200 is four-fifths of $250. So, we need to reduce the lot size by fifth. In this case, that gives us a lot size of 0.4.
To conclude, if we entered a buy trade for XAUUSD at 1847 with a stop loss of 1842, and the stop loss was triggered, a 0.4 lot trade would mean a loss of 2%.
Now you can see how your lot size is affected by the size of your stop loss and general good risk management practices.
Mini lot, micro lot and nano lot
Using a standard lot means that 1 lot equals 100,000 units of the base currency.
However, there are different, smaller measurements of lot size.
- A mini lot is 10,000 units of the base currency. 10 mini lots is the same as 1 standard lot.
- A micro lot is 1,000 units of the base currency.
- A nano lot is 100 units of the base currency.
It’s possible to get forex trading accounts which are based on these lot sizes.