A lot is a unit for measuring the volume of a position, which is a fixed amount of the base currency in the Forex market. Its transaction volume is indicated exclusively in lots, the size of which directly affects the level of risk. The larger the volume of one lot in Forex, the greater the risk. The risk assessment (risk management) system includes a model that allows, based on the level of perceived risk, volatility (stop loss level) and leverage, to calculate the optimal standard lot volume in foreign exchange markets. What this model is, how to use it and how a trader’s calculator can help, read the article.
Lot on Forex: a model for constructing an optimal risk management system
In the usual sense, a lot is a standard unit for measuring the volume of a currency position that a trader opens. That is, the amount of money that an investor invests in the purchase of a particular currency with a view to its subsequent sale at a better price. Lot calculation is one of the components of the risk management system recommended for those who approach trading in a balanced and structured way.
From this review you will learn:
- What are a lot and its interpretation options?
- How to calculate the lot of size in the Forex market. Calculation methods and practical examples with building a model in Excel.
- How to use the trader’s calculators and build a strategy using it.
What is a lot
Forex trading allows opening deals only with certain volumes of trading units, which are called lots. The trader does not have the opportunity to buy, for example, exactly 1000 euros, he can buy 1 lot, 2 lots or 0.01 lots, etc.
The standard Forex lot is 100,000 units. base currency. For example, if the EUR / USD quote is 1.1845, then a position with a volume of 1 lot will be equal to 118,450 units of the base currency, that is, exactly what you need to give back US dollars to buy 100,000 euros.
What is 1 lot in Forex?
- Mini lot (spelling options: mini lot, a mini lot) – equal to 0.1 standard lot.
- Micro lot – equal to 0.01 standard lot.
Most traders for different types of accounts set the minimum and maximum lot requirements. The upper bar is most often limited to 100 lots, the lower – 0.01 lots. If you take the example above, then the minimum investment will be $1,184. If you use the leverage 1: 100, then a minimum deposit of $11.84 will be enough to start. True, provided that all 100% of the money (which is unacceptable from the point of view of risk management) will be invested in the transaction. There is a second option – use cent accounts (if the broker provides such an opportunity). The only difference between cent accounts is that the calculations here are in cents rather than dollars, $11.84, in this case, is enough to buy a minimum micro-lot without using leverage.
On this screen, an order from MT4. The trader indicates in it a lot of sizes provided for by the settings, and he can only increase the deal step by step, the step is also provided for by the specification of the account. For example, according to the Classic account, the minimum step is 0.01 lots. In the drop-down list on the screen after a lot of 0.05, there is a lot of 1.00. This is done for visual convenience, in fact, there are no restrictions – a trader can manually enter the position volume of 0.06, 0.07 lots, etc.
Important! Despite the classic terminology, some brokers allow themselves to move away from it. For example, one of the brokers immediately warns traders that 1 lot is equal to 10,000 basic units of currency. Perhaps this is done to reduce the minimum deposit amount without leverage. In any case, before starting trading, we carefully read the offer, the specification of the account and contracts.
Depending on what is a trading unit (a lot, mini or micro lot), and also depending on what is meant by it, the price of a point is determined.
Example. A trader buys euros at the rate of EUR / USD = 1.1845. Estimated transaction volume – 0.01 lots. After the rate rises by 10 points (to 1.1855), the trader sells the euro. His income will be: 1000 (the size in basic units of 0.01 lots) * 0.0001 (1 point) * 10 (profit). Result: the trader’s income is $1. That is, a trader, having invested 10 US dollars, with a leverage of 1: 100 with an increase in price by 10 points, would have earned 1 US dollar.
The point value for a standard lot:
- Full lot: 1 point makes a profit of $10.
- Mini Lot: 1 point – $1.
- Microdot: 1 point – 10 cents.
And if, nevertheless, if 10,000 base units are taken as the basis for the lot, then the price of a point for 1 lot will be $1, for a mini lot – 10 cents, etc.
Management of the volume of open positions includes the following points:
- Determining the optimal ratio of open transaction volume and risk level. High volatility can instantly reset the deposit, the task of the trader is to choose the optimal ratio of the volume of open transactions to the deposit-taking into account the risk. In markets with a strong trend, transaction volume management involves the use of lot increase ratios (an element of the Martingale strategy).
- Assessment of the viability of a common market position. “Closing losing trades or staying a loss?” It is a classic Forex question that can be answered by managing the volume of transactions. The risk management policy provides for the creation of a model that would allow, by adjusting the position volume and leverage, to select the optimal resistance and support levels without touching the stop out. In simple words: there is a stop-out level, there is a strong level where, with a high probability, the price will change direction. The model will allow you to choose the optimal position volume at which the deposit will withstand the drawdown to the main level without clinging to a stop out.