Forex Lots and Pips : These two words are often used by every day traders, but surprisingly, some traders mix-up the two or use them wrongly.
We will simplify these Forex terms in this article.
What is a Lot?
A Forex lot is a standard number of units used to represent the quantity of a currency. A lot is an industry recognized standard and Brokers refer to lots by increments of 1000. A lot size also translates to the amount or risk you’re taking, the bigger the lot size, the bigger the risk.
Instead of saying…” I wish to trade 1000 units of a the EURUSD” where the EURO is the base or transaction currency, I’d therefore should say…” I wish to trade a Micro Lot of the EURUSD”.
Using the right Forex trading terms simplifies the trading and unifies the Forex market where everyone speaks one language. Lots are frequently used in Forex trading and is recognized globally.
Type of Forex Lot Sizes
Further to the basics, we will then proceed to the different types of lots and what they represent.
Due to increased competition, most brokers now split a standard lot (100,000 units) into smaller lot sizes to accommodate more investors. Forex accounts have smaller lot sizes to include retail Forex traders. The maximum lot size allowable for each account package is a feature that categorizes one trader from the other.
VIP accounts are now introduced with a Mini to a standard lot size feature, enabling traders execute trades according to capital size.
Lots are further categorized into the following:
Nano Lot -100 units
A nano lot is also referred to as the cent lot which is the smallest size of a standard lot (100,000 units). A nano lot is represented as 0.001 standard lot or $100.
A Forex trader with a $10 Cent account balance buys the USDJPY and sets a 15 pip stop loss or 15%.
Assuming in the course of trading, the pair dips and hits the stop loss, this means the trader losses 15 pips ($1.5) which may be small in face value but huge in relative terms to his $10 capital.
The downside to Nano lots is that balances has a high risk of getting blown up quickly during deep currency price swings.
Very small lot opens a trader to very thin trades and limited market opportunities.
As stated earlier, Nano lots are also at the mercy of market volatility as sharp downwards swings could mark the end of that account, not giving any room for a bounce back.
Many brokers tactically downplay the nano lots due to heavy transaction costs. Trading nano lots on cent accounts for example are used to encourage newbie traders to sign up with a smaller capital translating to smaller risk size, at the end, these class of clients make up the larger percentage of the broker clients which comes with lots of stress.
Most of the time, these accounts are usually left unfunded and sometimes abandoned by the clients.
A few brokers discourage this by raising the minimum account opening balance high. Some brokers start at $250 to as high as $1000 for a live account with Micro lot size being the starting point for retail traders and investors.
SEE ALSO: Best Lot Size for an Opening Balance of $500
SEE ALSO: How To Use A Forex Lot Size Calculator Like A Pro
A few trusted brokers offering Nano lots.
Micro Lot – 1000 units
Micro lot refers to 1000 units of a base currency and is a hundred times smaller than a Standard lot.
Micro lot size (bigger than the Nano lot size) allows a trader make smaller incremental sizes therefore creating avenues for fine tuning of his strategy.
If your account is funded in the USD, a Micro lot is worth $1000. If you’re trading a USD currency pair, 1 pip or point is the same as 10 cents.
A few trusted brokers offering Micro lots.
Mini Lot – 10,000 units
The Mini lot is one-tenth the size of a Standard lot (100,000 units). 1 pip of a currency pair with USD as the base currency is $1.00.
The Mini lot is common with many retail Forex traders because it offers better flexibility in trading. This lot size is popular among many brokers.
Mini lot size is a perfect start for beginners in Forex trading.
A few trusted brokers offering Mini lots.
Standard Lot – 100,000 units.
A standard lot is an equivalent of 100,000 units of a base currency. This is where bigger institutions play, profits here are massive and vice-versa. An average pip size for a standard lot represents $10 per pip. This also means, a $100 gain when prices go in your favor and a loss in such magnitude when prices go south.
With this in mind, trading standard lots require a minimum of $25,000 or more. It is recommended that trading Standard lots require skill and experience as a Single pip dip is usually a major hit on the account balance.
Brokers offering Mini lots.
What is a Pip Value?
Movement in currencies are measured in pips. Since currencies are quoted in four decimals (E.g. – 1.1015). The slightest movement in a currency pair is referred to as a Pip.
A Pip (Percentage in Point) value is how much one pip is worth in one lot. A pip is 1/100 of 1% or one basis point of Standard lot.
In other terms, a Pip is one hundredth of one percent or 0.0001.
For instance, the smallest rise or dip of a currency pair is 0.0001 or one basis point.
So, 1 pip of a Standard lot = $10
If a trader buys the EURUSD and hopes to profit from the base currency, Euro. Assuming he purchased Euro for 1.1088 and exits his trade at 1.1163, it therefore means that he made 75 pips.
As little as 75 pips may seem, in huge forex transactions, it adds up to a lot of money.
Assuming he purchases a Standard lot (100,000 units) of the Euro, it then means he made $750.
Choosing the Right Lot size
Knowing the right lot size depends on the tools you’re using to measure your risk since lot size directly impacts account balance.
There are risk management calculators that analysis currency pairs, amount you wish to risk, stop loss and your account balance.
What this calculator does is to compute the data provided and presents the right amount of lots to trade. This of course can be computed manually which will be explained in the next title.
Remember, trading lot sizes impacts your account directly. We recommend increasing your lots gradually, but first check what you can afford to lose.
How to Calculate a Lot Size.
Let’s look at this scenario in determining a lot size.
Account Currency: USD
Account Balance: $1000
Stop loss: 60 pips
Currency Pair: EURUSD
Step 1: Calculate amount at risk
Calculate risk percentage from account balance:
$1000 of 2%
$1000 x 0.02=$20.
Step 2: Calculate Pip Value
$20 / 60 Pips = $0.33/Pip
Step 3: Calculate Lot size (number of units)
$0.33 per pip x [(10,000 units of EUR/USD) / ($1 per Pip)] = 3,300
No of units of EUR/USD = 3,300 or 3 Micro Lots and 0.3 Mini Lots
Forex Lot Size calculator
Now you know the basics, you may want to use our Lot size calculator for a quicker result.
This calculator computes your trade data and presents the right amount of lots to trade.
Getting used to the world of forex takes a bit of time. Continuous learning and focus sharpen knowledge and improves one’s skill faster.
Lots and Pips are Forex terms, understanding these terms enlightens you on the type of lot sizes to trade, risk management which includes applying stop loss and valuing the smallest pip in every trade.
Image Credit: Money vector created by freepik – www.freepik.com
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