In the past, spot forex was only traded in specific amounts called lots. The standard size for a lot is 100,000 units. There are also a mini, micro, and nano lot sizes that are 10,000, 1,000, and 100 units respectively.
As you may already know, the change in currency value relative to another is measured in “pips,” which is a very, very small percentage of a unit of currency’s value. To take advantage of this minute change in value, you need to trade large amounts of a particular currency in order to see any significant profit or loss.
Let’s assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value.
- USD/JPY at an exchange rate of 119.80(.01 / 119.80) x 100,000 = $8.34 per pip
- USD/CHF at an exchange rate of 1.4555(.0001 / 1.4555) x 100,000 = $6.87 per pip
In cases where the U.S. dollar is not quoted first, the formula is slightly different.
- EUR/USD at an exchange rate of 1.1930(.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip
- GBP/USD at an exchange rate or 1.8040(.0001 / 1.8040) x 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.
Your broker may have a different convention for calculating pip value relative to lot size but whichever way they do it, they’ll be able to tell you what the pip value is for the currency you are trading is at the particular time. As the market moves, so will the pip value depending on what currency you are currently trading.
Depending on your account equity and leverage, the maximum lot size can vary as well as the pip value for 1 pip as shown in the table below.
Risk Management and Lot size
The lot size that is used to trade new positions will vary based on your risk aversion profile as well being defined by the trading strategy you follow. Most beginners usually tend to randomly make use of various lot sizes on whims and fancies. Having an understanding of the risk management and the lot size therefore can be greatly beneficial.
For example, one of the common risk management strategies is not to risk more than 2% of account equity. Going by this logic, assuming that a trader has $100,000 account equity then maximum allowed amount to risk would be $2000. Based on the risk information, we can deduce the pip value deviation as shown in the table below.
|Lot Size||Pip Deviation||Value|
|100,000 (1 Lot)||200 Pips||$2000|
|10,000 (0.1 Lot)||2000 Pips||$2000|
As evident from the above table we can notice that depending on the lot size opened the amount of leeway that can be given vastly increases. A 0.1 lot offers much more flexibility compared to 1 lot when it comes to both risk management and pip deviation.
Which lot size is best?
While the answer to the above can vary from one trader to another, it is always advisable to choose a forex broker that offers micro lots. Some forex brokers usually offer a mini lot as the minimum standard lot based on the account equity with a minimum deposit of $10,000 and above. In conclusion, understanding lot size is important to managing risk in forex trading. Therefore, choose the lot size that you trade with carefully.
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