Choosing a Lot Size in Forex Trading
When you first get your feet wet with forex training, you'll learn about trading lots. A lot references the smallest available trade size that you can place when trading currency pairs on the forex market. Typically, brokers will refer to lots by increments of 1,000 or a micro lot. It is important to note that the lot size directly impacts and indicates the amount of risk you're taking.
Lot Size Matters
Finding the best lot size with a tool like a risk-management calculator or something similar with a desired output can help you determine the best lot size based on your current trading account assets, whether you're making a practice trade or trading live, as well as help you understand the amount you would like to risk.
The trading lot size directly impacts how much a market move affects your accounts. For example, a 100-pip move on a small trade will not be felt nearly as much as the same 100-pip move on a very large trade size.
You will come across different lot sizes in your trading career, and they can be explained with the help of a useful analogy borrowed from one of the most respected books in the trading business.
Trading with Micro Lots
Micro lots are the smallest tradable lot available to most brokers. A micro lot is a lot of 1,000 units of your account-funding currency. If your account is funded in US dollars, this means that a micro lot is $1,000 worth of the base currency you want to trade. If you are trading a dollar-based pair, 1 pip would be equal to 10 cents. Micro lots are very good for beginners that want to keep risk to a minimum while practicing their trading.
Moving Up to Mini Lots
Before micro lots, there were mini lots. A mini lot is 10,000 units of your account-funding currency. If you are using a dollar-based account and trading a dollar-based pair, each pip in your trade would be worth about $1.00. If you are a beginner and you want to start trading using mini lots, make sure that you're well-capitalized.
While $1.00 per pip seems like a small amount, in forex trading, the market can move 100 pips in a day, sometimes even in an hour. If the market is moving against you, that adds up to a $100 loss. It's up to you to decide your ultimate risk tolerance but to trade a mini account, you should start with at least $2,000 to be comfortable.
Using Standard Lots
A standard lot is a 100,000-unit lot. That is a $100,000 trade if you are trading in dollars. The average pip size for standard lots is $10 per pip. This is better remembered as a $100 loss when you are down just 10 pips. Standard lots are for institutional-sized accounts. That means you should have $25,000 or more to make trades with standard lots.
Most forex traders that you come across are going to be trading mini lots or micro lots. It might not feel glamorous, but keeping your lot size within reason relative to your account size will help you preserve your trading capital to continue trading for the long term.
A Helpful Visualization
If you have had the pleasure of reading Mark Douglas' Trading In The Zone, you may remember the analogy he provides to traders he has coached, which he shares in the book. In short, Douglas recommends likening the lot size that you trade and how market moves would affect you, to the amount of support you have under you while walking over a valley when something unexpected happens.
To illustrate this example, a very small trade size relative to your account capital would be like walking over a valley on a very wide, stable bridge where little would disturb you even if there was a storm or heavy rains. Now imagine that the larger the trade you place the smaller and riskier the support or bridge under you becomes.
When you place an extremely large trade size relative to your account balance, the bridge gets as narrow as a tightrope wire, such that any small movement in the market would be like a gust of wind in the example, and could send a trader the point of no return.