When you first begin trading, one of the most important things that you will need to wrap your head around is the idea of your lot sizes.
When you enter a position in forex, you will be buying in a predetermined number of units, also known as a lot. There are three commonly used lot sizes in forex, these are displayed in the table below.
Historically, forex has only ever been traded in these predetermined lot sizes.
Due to the rise in popularity of forex and the increasing competition brokers have begun adding more lot size options and have become much more flexible in order to enhance the trader’s experience. Good news for us!
Choosing your lot size
The best way to look at lot sizes is to think of their value in USD per pip.
Most beginner traders will not start off trading with one lot unless they have a large starting trading capital. However, even if this is the case it is advised to stick to smaller sizes until you learn the ropes.
Luckily, most if not all brokerages will allow you to choose your own lot size so that you can trade freely and set your own levels of risk.
One standard lot (commonly referred to as just “one lot”) is 100,000 units of the base currency. This is typically the benchmark that we will work with for our trades.
If we trade with one lot (100,000 units) then each pip will be worth $10.
Here are some common lot sizes and what one pip value would equate to.
- 5 lot = $50 Per pip
- 2.5 lot = $25 Per pip
- 1.00 lot = $10 Per pip
- 0.10 lot = $1 Per pip
- 0.05 lot = $0.5 Per pip
Why is choosing the correct lot sizes important?
Choosing the correct lot size is vital when it comes to foreign exchange trading. If you want to trade correctly then you must consider your lot size carefully.
The size of the lot you buy directly impacts how much exposure your account has to the market and how market fluctuations will affect your overall account balance.
Too big of a lot size and you will be overexposed, causing your account to be at increased risk.
The larger the lot size, the more that each pip movement will affect your account.
As a beginner trader, it is very easy to overexpose yourself and trade at too high a position size. This is the easiest way to blowing your account and becoming a losing trader.
Trading is a marathon, not a sprint.
Let’s take a look at some pip movements and how our lot size would affect our overall trading account.
Lot size risk management
Note: Lot size risk management is one of the most vital components of becoming a successful forex trader. We cannot stress this point enough.
Some may even argue that this is the single most important factor in becoming a profitable foreign exchange trader and protecting yourself from blowing your account. Please take your time to thoroughly read and understand this part of the course.
The journey to becoming a successful trader is a difficult one – you will almost certainly make some mistakes along the way. If you stick to the information you learn in this course and manage your risk effectively with optimal lot-sizing then you will be well on your way.
As we mentioned, risk management is there to help you protect you from blowing your account. However, it also protects you from being too cautious.
Even if you have the greatest forex strategy in the world, a poor risk management system will almost certainly end in you trading unprofitably.
With that being said, here are our risk management guidelines.
Lot size recommendations
Luckily, it’s pretty simple to figure out your lot size. Here are the sizes we recommend.
For every $1,000 you can trade with a 0.1 lot size.
So why do we recommend these levels?
Imagine you have a trading balance of $1,000 and you decide to trade with a 1.0 lot.
We know that a 1.0 lot equates to a pip value of $10 and as we mentioned earlier, the average currency pair can easily move 100 points in one day.
-100 pips x $10 = -$1,000
As you can see, if you open a trade without a stop loss and it goes against you, you could wipe out your entire account in one single day.
If you stick to the recommended lot sizes in the table above then you will drastically reduce the chances of losing your account. The losses that you will inevitably face will become much easier to manage.
For example, with the same $1,000 we would recommend using a 0.1 lot size which has a pip value of $1. Let’s now use the same scenario as before.
-100 pips x $1 = -$100
In the same trade, we have cut the potential loss down by 90%. In order to blow your account, you would now have to lose ten trades in a row which is extremely unlikely, even if you have a poor win rate.
You may already be thinking that even though this minimizes our losses, it also reduces our potential for profit. While this is true, account preservation and protecting your capital is one of the most important skills a trader can learn.
After all, you cannot trade if you don’t have any money in your account.
Tip: Make sure you apply these rules EVERY single time you trade, with no exceptions. It’s a tool that will protect your overall account balance while still giving you enough room to make some nice profit.
We will look at risk management in much greater detail in Unit 5 where we will show you some other strategies and skills that you can use to minimise your risk even further. So, for now, let’s carry on with some of the basic fundamentals of understanding the market.