CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75.00% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
In forex trading, a lot is a standard unit of measure to determine the volume of your trading position. It has a direct impact on the risk level you will be exposed to. So, the greater the position volume or lot size, the greater the risk. This is why understanding what lot size is and how to calculate it holds huge importance for risk management while trading forex. By choosing the appropriate lot size, you can limit the risk based on your risk appetite. It also helps you determine where to place your stop loss and how much leverage to use.
A standard lot in forex trading is 100,000 units of the base currency. For example, if you are trading the EUR/USD and the rate is 1.1027, you will need 110,270 units of the US dollar to open a position worth one standard lot. This is because, at the current exchange rate, $110,270 will help you buy €100,000, the base currency.
Depending on your trading capital and risk tolerance, you can also choose to open smaller positions of a mini lot (0.1 of a standard lot), a micro lot (0.01 of a standard lot) or a nano lot (0.001 of a standard lot).
| Lot Size | Units of Base Currency |
| Standard Lot | 100,000 units |
| Mini Lot | 10,000 units |
| Micro Lot | 1,000 units |
| Nano Lot | 100 units |
Although you won’t need to manually calculate the lot size since your trading platform is likely to provide you with a position size calculator, it is important to know how the calculation is done. The formula to calculate lot size is:
Lot size = (Risk amount / (Stop loss in pips x Pip value))
Here, the risk amount is the capital you are willing to risk on this trade, the stop loss is your predetermined exit level to limit losses, and the pip value is the pip movement of your chosen currency pair. Experienced traders prefer to keep the risk amount low, at 1%-2% of their total trading account balance for a single trade.
You should also know how to calculate lot sizes for direct currency quotes and cross rates. The formulae are:
Determining your position size needs a little thought, especially if you are trading via CFDs. This means you need to account not just for the capital you invest in a trade but also for the money you borrow as leverage and the amount you need to maintain in your trading account to keep your position open. With CFD trading, you could even hedge your position by opening two trades of different lot sizes. However, remember that the larger the leverage ratio, the more capital you need to maintain in your trading account.
The most important factor in choosing your lot size is the risk you are willing to take. The larger the lot size, the more capital you will need to invest or leverage you will need to use. This will magnify the impact of pip movements and, therefore, your overall trade. Let’s understand this EUR/USD example:
So, the smaller your lot size, the less the cost of every one pip move. This highlights the importance of knowing what to consider while choosing your lot size and risk management.
What the right lot size is for you will differ according to the currency pair you choose, the capital you have available for trading and your knowledge of the market. Some of the other factors to keep in mind include:
If higher risk causes you stress, it is best to stay with smaller lot sizes. This will limit your exposure to the market and, therefore, your potential gains and losses.
The volatility and liquidity in your chosen forex pair will impact the risk levels. Smaller lots can help limit risk in volatile markets and when liquidity is low. Low liquidity increases the chances of slippage, which can lead to delays in trade execution.
Scalpers and day traders tend to choose smaller lot sizes, compared to position traders. This helps them manage risks while opening and closing multiple positions throughout the trading session.
Not all brokers offer micro and nano lots on their trading platforms. If you are a beginner, choose a broker who allows you to start small and gradually increase your position size as you gain confidence and experience.
Regardless of the lot size you choose, the importance of risk management cannot be overemphasised. Once you know what the right lot size is for your trading strategy and trading psyche, remember to include stop loss and take profit orders while opening a position. Also, choose the leverage wisely, since trading on margin increases market exposure, which magnifies both profit and loss potential.
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