One of the biggest mistakes beginners make is not understanding what lot size to use in Forex trading. Most beginners practically spend all of their time thinking about when to buy and less time assessing their risk levels properly.
One crucial component to trading, part of the basics itself, is risk management and how to determine Forex lot size. After all, you want to make sure that you’re comfortable when trading because risk is inherently involved.
Then there are the few beginners who have taken the time to learn something first. They hear about risk management and how that is the key to success. But still, they may not fully understand how to properly assess their risk when trading.
This article is for everyone who wants to learn more about what lot size to use in Forex trading. You will understand how to determine lot size based on several different factors.
What lot size to use in Forex trading
You’ve probably heard it before but, successful trading is all about managing risk. Of course, timing the market, entries and exits are important. But risk management is integral to trading and is one of the most important components to your success. Part of risk management is understanding what lot size to use in Forex trading.
Don’t be one of those traders who lose all the money in their account because they selected the wrong lot size. To avoid this from happening, you should know how to determine Forex lot size correctly.
In order to do that, there are several variables that need to be taken into account. I will explain what they are in just a moment, so stick around until the end but let’s start with and cover the basics first.
What is a Forex lot size?
A lot size, position size, deal size or the trading volume is the amount you want to trade and this has a corresponding level of risk. The higher the lot size, the more you can potentially make or lose in the market.
The most popular trading platforms today, MT4 & MT5 allow you to trade lot sizes that practically anyone would be comfortable with. You can also trade lot sizes that are just unrealistic for the vast majority of people due to capital and leverage limitations.
Anyway, when trading in the Forex market, you are faced with the decision on what lot size to use. The primary reason why traders use different lot sizes is to balance risk versus reward. Lot sizes are available in different presets and the first and smallest lot size is;
Micro lot
Brokers set micro lot sizes at 1,000 units of the currency being traded. On the MT4 & MT5 trading platforms, the volume is 0.01 lots. These lot sizes are typically used by traders who are just starting out or who only trade small positions in their accounts. Since this lot size is small, they also allow traders to be more precise with the trading volume they want to trade.
Mini lot
The next step up is a mini lot, which is a lot size of 10,000 units of currency. This is a popular size for traders who want to trade large positions but don’t want to risk too much. Mini lots provide good profit potential with a comfortable risk profile for most traders. Generally speaking, once you are trading accounts funded in the thousands, stepping up to mini lots is a feasible option.
Standard lot
Finally, there’s the standard lot size of 100,000 units of currency per contract. This lot size is usually used by traders who want to max out their profit potential and are willing to take on more financial risk. Typically, this lot size is used by larger traders with accounts funded in the tens of thousands.
Trading with custom lot size
Given these three standard lot sizes, they are not the only option as you can trade them in multiples. For example, you can trade three mini lots which is 30,000 units of currency. Or five standard, three mini and one micro lot, which is a lot size of 531,000 units of currency.
You do have flexibility to trade any lot size that you like with step increments of 0.01 lots. So long as you can meet the margin requirement to open the trade.
Why position and lot sizing matters
It’s important to choose an appropriate lot size when trading because it can mean the difference between risking too much or too little. The choice between small and large lots also has an impact on your profitability. When you trade small lot sizes, the risk will be small but so too will the rewards.
The lot size you choose is the amount of money you want to trade and this is directly related to the pip value. When you know this, it makes position sizing easier but there are a couple more variables in the equation that you must know to trade the correct lot size. These are, how much you are prepared to risk on the trade and how much adverse price movement you are prepared to accept before stopping the trade. When you know these, you can calculate the pip value and what lot size you should be trading.
How to determine Forex lot size
Here is the formula to go about choosing the correct lot size.
Amount to risk / risk in pips = pip value
Let’s look at an example.
Let’s say that you want to risk $100 trading on the EURUSD and intend to put a stop loss 50 pips away from your entry price. Using the formula above, you can work out the pip value as follows.
Now that you know the pip value, you can work out the corresponding lot size. The lot size you should trade, should have a pip value of no more than $2 in order to not exceed the $100 risk. So going by the table above, it would be 2 mini lots or 0.20 lots on the MT4 or MT5 trading platform.
You could rearrange the pip value formula too, to work this out but there are easier and more convenient ways to do it. Such as remembering the pip value for standard, mini and micro lots, or using a pip value or lot size calculator.
Conclusion
You have to decide what lot size works best for your account size, tolerance to risk and trading style. Some traders might feel more comfortable with a small lot size because it’s much easier to stomach losing a few hundred dollars than it is losing thousands of dollars. Others might feel more comfortable with a larger lot size because they can afford to lose more money. As that may still just be a relatively small percentage of their trading account.
But no matter how confident you are about your analysis and trade idea, risk management is mutually exclusive and separate. There are some basic rules of thumb that can help guide you toward selecting the right lot size for your trading account. Which is to risk a small percentage of your account, identify your stop loss or cut off point and trade a lot size adequate for that.