Choosing a Lot Size in Foreign Exchange/Forex Trading
What Is a lot? A lot references the smallest available trade size that you can place when trading the Forex market. Typically, brokers will refer to lots by increments of 1000 or a micro lot. It is important to note that lot size directly impacts the risk you are taking.
Therefore, finding the best lot size with a tool like a risk management calculator or something with a desired output can help you determine the desired lot size based on the size of your current accounts, whether practice or live, as well as help you understand the amount you would like to risk.
Lot size directly impacts how much a market move affects your accounts so that 100 pip move on a small trade will not be felt nearly as much as the same hundred pip move on a very large trade size. Here is a definition of different lot sizes you will come across in your trading career as well as a helpful analogy borrowed from one of the most respected books in the trading business.
Using Micro Lots
Micro lots are the smallest tradable lot available to most brokers. A micro lot is a lot of 1000 units of your accounting funding currency. If your account is funded in US dollars a micro lot is $1000 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 need to be more at ease while trading.
Using Mini Lots
Before micro lots, there were mini lots. A mini lot is 10,000 units of your account funding currency. If you are trading a dollar-based account and trading a dollar-based pair, each pip in a trade would be worth about $1. If you are a beginner and you want to start trading using mini lots, be well capitalized.
$1 per pip seems like a small amount but 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 is 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 $2000 to be comfortable.
Using Standard Lots
A standard lot is a 100k 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 only down 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 be glamorous, but keep your lot size within reason for your account size will help you to survive 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 that is shared in the book. In short, he recommends likening the lot size that you trade and how a market move would affect you to the amount of support you have under you while walking over a valley when something unexpected happens.
Expanding on this example, a very small trade size relative to your accounts would be like walking over a valley on a very wide and 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 the support or road under you becomes.
When you place an extremely large trade size relative to your accounts, the road gets as narrow as a tightrope wire, such that any small movement in the market much like a gust of wind in the example, could send a trader the point of no return
Edited by Tyler Yell