What is a lot size and how to calculate a lot in Forex?
- What lot size to use in forex: building an optimal risk management system?
- What is the lot size in Forex?
- Understand Pip Value for a Trade
- Position size: what it is and why it is important?
A lot is a unit of position volume, which is a fixed amount of the base currency in the Forex market. Its volume in trade is stated solely in lots, the size of which directly affects the level of risk. The higher the volume of one lot in Forex, the greater the risk. A risk management system includes a model that allows calculating the optimal lot size for the forex markets based on the anticipated risk level, volatility and leverage What is this model is, how to use it and how the trader´s calculator can help you.
What lot size to use in forex: building an optimal risk management system
In the traditional sense, a lot is a standard unit of volume of the currency position, which opens the trader. That is the amount of money that an investor invests in buying one currency or another to sell it later at a more favourable price. The calculation of lots is one of the components of the risk management system that is recommended for those who approach trading in a balanced and structured manner.
What is a lot?
Forex trading allows trading only with a certain volume of trading units called lots. A trader cannot, for example, buy exactly 1000$, he can buy 1 lot, 2 lots or 0.1 lots and so on.
A standard forex lot is 100,000 units of the base currency. For example, if the EUR/USD quote is 1,1845, then a position of 1 lot will be equal to 118,450 units of the base currency, i.e. that is how much U.S. dollars you need to give to buy 100,000 euros.
What is 1 lot in forex:
A mini lot equals 0.1 of a standard lot.
A micro lot equals 0.01 of a standard lot.
Most traders set the minimum and maximum lot requirements of accounts of various types. The upper limit is usually 100 lots, the lower limit is 0.01 lots.
Taking the example above, the minimum investment would be $1.184. U.S Dollars. If you use 1:100 leverage, then a minimum deposit of USD 11.84 will be enough to get you started.
The minimum deposit of 11.84$ would be enough to start with. True, on the condition that 100% of the money (which is unacceptable in terms of risk management) will be invested in the transaction.
Managing the volume of open positions involves the following points:
Determining the optimal ratio between the volume of open trades and the level of risk. High volatility can instantly bring the deposit to zero, and the trader's task is to find the optimal ratio of the volume of open transactions to the deposit, taking risk into account. On the markets with a strong trend, the deals' volume management provides for applying the lot increase ratios (element of the Martingale strategy).
Evaluating the viability of the overall position in the market. "Closing unprofitable trades or waiting out losses?" - is a classic Forex question that can be answered by managing the volume of transactions. The policy of risk management is to create a model that would allow, by adjusting the position volume and leverage, to select the best resistance and support levels without touching a stop out. There is a stop-out level, but there is a strong level where the price is likely to change direction. The model allows selecting the optimal position volume, at which the deposit will survive a drawdown to the basic level without touching a stop out.
How to calculate the lot size in Forex
The easiest way to calculate the lot size in Forex is to use the lot size calculator.
Why calculate lot size at all:
Optimising the volume of a position concerning the amount of the deposit, taking into account the risk and the desired return on investment, allows you to balance your trading.
Proper lot selection and position ascending order allow selecting such a trading mode that the trader's total position is resistant to drawdowns, corrections, pullbacks and volatility.
Almost all trader's calculators have the same problem: there is no way to calculate lot volume linked to risk level, although that is exactly the point of planning trading volumes. I propose to use the following formula to calculate the lot volume linked to the risk level:
Lot Volume = (% Risk * Deposit)/A * (Price 1 - Price 2)
Risk % is an amount of deposit that a trader is ready to allocate for a deal (the recommended 5% I wrote above). A - is a coefficient equal to one for a long position and one with a minus sign for a short position. Price 1 and Price 2 are the opening price and stop-loss levels. The level of stop-loss, in this case, is one of the variants of interpretation of the average or maximum volatility, which I also wrote above.
What is the lot size in Forex?
Micro Lot size
Micro lot equals 0.01 of a standard lot or 1,000 units of the base currency.
Nano Lot size
Nano lot is equal to 0.001 of a standard lot or 100 units of the base currency. Rarely encountered in brokers´ trading conditions.
Mini Lot size
Mini lot equals 0.1 standard lot or 10,000 units of the base currency.
Understand Pip Value for a Trade
In technical analysis literature on forex and publications of traders and analysts, point and pips are used as synonyms, similar to what is generally accepted for forex trading training.
Some professional traders use "pips" several times a day which allows for earning good money in total with minimal risks.
This is a common exchange instrument, which helps to fix the minimal deviation of the price instantly. In the exchange market, the price of a currency is counted to the fourth digit from the right after the dot. The pip is the fourth digit, the change of which represents the smallest fluctuation in price. After the calculation, it becomes clear that the value of one pip is directly dependent on the currency pair.
Position size: what it is and why it is important
Position size is the trading volume by which a trade is opened. The more you buy, the bigger your profit from a one-point change in price if quotes go up. But your risks multiply if the price goes against you! That is why it is important to know how to properly calculate the size of a position.
What does the lot size you may enter into a trade depend on?
- The size of the deposit.
- The value of leverage.
- The mathematical expectation of the trading strategy.
- The size of the stop-loss.
Position Size: lot size determines how much of a position is opened.
The order of calculating the size of the open currency positions
Let´s look at an example of a currency pair to learn how to correctly determine the volume of an entry into a trade. You already know how to measure position size in Forex - it's a lot. For the major currency pairs, a lot is 10 or 15 thousand units of the base currency (the currency that comes first in a pair). Nowadays, brokerage companies offer the opportunity to trade not only in whole but also in fractional volumes. Therefore, the size of a currency position is the volume of the lot with which you will open a trade.
The first action of a trader is to determine the point of entering the position. According to the rules of trading strategy, you need to determine the entry price, stop-loss and take-profit level.
Suppose you decide to sell GBP/USD on a rebound from the resistance level of the descending channel. The profit potential in the trade is 150 pips, with a stop loss of 45 pips on market demand.
How to calculate position size
1. Based on the mathematical expectation of your trading strategy determine what the risk percentage of a single trade should be. Usually, it will be 1-2% of the deposit amount.
2. If the account has $10 000, then we calculate the amount of risk in money (x) using a simple proportion
$10 000 = 100 %
x = 1 %
x = 10 000 % * 1 % / 100 %
x = 100 $
That is you can lose no more than $100 in this trade.
3. Further you need to calculate the size of the position in terms of the value of one pip. The whole lot for GBP/USD pair will be $10.
4. Stop Loss in the transaction is 45 pips. So for the whole lot in money, it will be $450.
5. Allowed risk is $100, so the lot will be fractional. We calculate its size (x) using the proportion:
1 lot = $450
x = $100
x = 1 * $100 / $450
x = 0.22 (0.2 lots)