What is a Lot?
In the world of forex trading, the tiniest shifts in prices can instantly translate to thousands or even hundreds of thousands of dollars worth of profit in just a few seconds. This is why it is essential to understand the value and units of measurement that are used to determine these seemingly small shifts in currency values on the global marketplace.
This is where lots come in. In forex trading, lots are units that measure the size of a transaction. They describe the exact number of “units” of base currency that you will buy or sell. Lots are a globally standardised way of assessing and quantifying currrency transactions and there are various different types and sizes of lots that govern the vast majority of all global forex trades.
It is, therefore, essential for any trader to understand exactly what lots are and what their sizes mean and how they relate to your own investments, profits, and losses. With that in mind, let’s break down exactly what is meant by lots in forex trading.
Let’s start with the basics. A lot is a standardised unit of measurement denoting the number of units held in a particular currency. For example, a standard lot size is always 100,000 units of a given base currency. This means that, in USD/EUR for example, a standard lot would be equal to $100,000 US dollars. This is because 1 lot is equivalent to 100,000 units of USD.
Naturally, the vast majority of individual traders do not have this kind of cash to hand to be able to make such significant investment in individual trades. This is where leverage comes in. Leverage allows you to open positions that are hundreds of times larger than the amount of cash you actually invest because your broker is “lending” you the full amount and taking the initial amount as a good faith deposit.
Lots will determine the size of your position and will therefore tell you exactly how much profit you stand to gain or how much you stand to lose, as well as the exact level of risk you are taking on with a particular trade. It is for these reasons that all forex brokers and institutional investors use lots.
Why Is It Important to Know What a Lot Is?
No matter if you are a seasoned forex trading expert or a beginner in the world of currency markets, you absolutely need to understand lots and use them on a daily basis. As mentioned, your lots are units of measurement that determine the size of every single trade you are making, no matter your position. Lots come in various different sizes, which we will describe in greater detail down below.
When you are trading various different currencies that have vastly different values, such as US dollars vs Japanese yen, lots are a standardised way of allowing you to easily calculate the actual value of your trades, while also allowing you to quantify the precise level of risk that a forex trade or position holds.
Even the most well-informed trading strategy will fail if you do not know the exact lot size that you should be using. Lot sizes tell you how much leverage you will need to take on in order to make a certain amount of profit. They also tell you the exact value of each pip movement in a given currency pair. For this reason, a 40-pip downward movement on a small lot size trade will not be felt nearly as painfully as a 40-pip downward movement on a large (standard lot) size trade.
While there is a certain degree of mathematics involved in calculating lot sizes and pip values, you do not need to concern yourself with this. Any quality forex broker will come with an on-site pip size calculator that will instantly tell you the pip values relative to a given lot size. Using these will ensure that you are making genuinely informed trades and are able to put the right stop-losses in place to minimise risks.
While we have already touched upon what a standard lot size is, this is not the full story. While this is one of the most common types of lots that govern most forex trades, it is only the very largest lot that you can use. Generally, there are four types of lots that any forex trader can make use of: standard lots, mini lots, micro lots, and nano lots.
As you might have guessed, each of these lots is smaller in size than the last. Choosing smaller lot sizes might mean less profits, but it also means substantially less risk, as well as much smaller initial investments in a given forex pair. Let’s break down exactly what each lot size actually means, with the help of some real-world examples.
A standard lot is equivalent to 100,000 units of the base currency in your forex trade. It is the most common lot used by institutional investors and the default size that you will see on many trading platforms. In a standard lot, this means that a single-pip movement in either direction corresponds with a $10 change. For example, if you buy $100,000 against JPY at ¥110.00 and the price rate increases to ¥110.50, which is a 50 pip movement, it corresponds to a $500 profit. Likewise, if the price falls 50 pips to ¥109.50 you have made a loss of $500.
A mini lot is 10% the size of a standard lot, meaning that it is equal to 10,000 units of the base currency. Let’s say you are trading EUR/USD. A mini lot of this particular currency pair would be €10,000 EUR worth of US dollars at current market prices. Conversely, a mini lot of USD/JPY would be $10,000 worth of Japanese Yen at the time of the trade.
As you might have guessed by now, a micro lot is one-tenth of a mini lot or one-hundredth of a standard lot. Ergo, a micro lot is equivalent to 1,000 units of the base currency. For example, a micro lot, also referred to as a 0.01 lot, of EUR/USD would be equivalent to €1000 EUR worth of US dollars at the time of the trade. Conversely, a micro lot of USD/JPY would be equivalent to $1000 USD worth of Japanese yen at the time of the trade.
A nano lot is typically the smallest possible lot size that you can purchase and trade with on any forex market. Not all forex brokers actually offer nano lots, but they are becoming an increasingly popular way for traders who are reluctant to use leverage to access currency markets. A nano lot is also known as a 0.001 lot and is equivalent to 100 units of your base currency. In EUR/USD, for example, a nano lot would be €100 EUR worth of US dollars at the time of the trade. Conversely, a nano lot of USD/JPY would be equivalent to $100 USD worth of Japanese Yen at the time of the trade.
Why Is Lot Size Important in Your Trading?
Lots are used to calculate the size of the trades you are making and the size of the risk that you are taking on. You can use a pip calculator to quickly determine how much each pip movement is worth to you based on the lot size that you have invested in.
This is essential as it can help you to put together a viable risk management strategy and ensure that you do not over-stretch your resources. In addition, currency pairs, by nature, involve two assets worth different amounts that are constantly changing relative to each other. Lot sizes are a globally standardized way to avoid confusion and to retain a crystal-clear idea of how much you are investing.
How to Use Lot Size in Your Trading
Lot sizes are primarily used to calculate risk and determine the size of the leverage that you are willing to take on. This will allow you to put together a stop-loss plan that works for you. For example, if a currency pair typically moves around 100 pips per day, but your maximum stop-loss is only $200 per day, there is no way that you would want to open up a standard lot size position into that pair, as your potential losses would reach thousands of dollars.
Only Trade with Licensed and Trusted Forex Brokers
When trading and choosing forex lot sizes, you will often need to use leverage in order to make any decent profits. For this, it is absolutely essential that you use a licensed and trustworthy forex broker. To find out the UK’s top forex brokers, simply consult our in-depth reviews and guides today.