Risk management and money management are some of the most crucial factors when it comes to Forex trading. Without these, a trader won’t keep the pips he makes. It doesn’t matter if one happens to go up by 1000 pips on a single trade if he lets them all go back to the market before it closes out. A good trader knows when to open and close a trade as well as how to manage his lots.
In the Forex market, the term ‘lot’ usually refers to the minimum transaction amount for a particular currency pair. Lot sizes will usually be indicated in terms of the base currency for that pair, but might also be denominated in US Dollars because of the great frequency of trading in that currency.
The Interbank Forex market does not usually have lot sizes since nearly any amount can deal in the over-the-counter or OTC Forex market. The concept of lots seems to have been borrowed by retail Forex brokers from the futures market where currencies have been traded in lots for years.
In trading Forex wherein fixed lot sizes are used, a trader’s work is simplified to some extent since they can deal and think in terms of the number of lots rather than the exact amount of currency traded. However, trading in lot sizes does somewhat reduce a trader’s ability to tweak the sizes of his positions to the defined amount of trading risk that he wishes to take.
Lots and Account Sizes
A standard lot refers to 100,000 units of the base currency for any currency pair that a trader is working with. When trading one standard lot with the USD as the base currency, each pip is worth $10. So if a trade goes down to 10 pips, this is equivalent to a $100 loss. Standard lots are for institutional sized accounts and require at least $25,000 to make trades.
A mini lot is equivalent to 10,000 units of the base currency for any pair. If trading with USD as the base currency, each pip in a trade would be worth about $1. While a dollar per pip seems like a small amount, it’s crucial to remember that the Forex market is very volatile and the markets can move 100 pips a day or sometimes even within an hour. If the market is against you, then that means a $100 loss for you. To trade with a mini account, a trader should start with at least $2000.
Mini accounts are quiet popular among beginning traders. There are also several experienced Forex traders who take advantage of the smaller mini lot sizes as these allow greater flexibility to allow new strategies or build trading positions for specific amounts.
After mini lots, there are micro lots which basing from its name, are smaller than the standard lots and mini lots. These are the smallest tradable lot sizes offered by most Forex brokers. This is equivalent to 1000 units of the base currency. Each pip is equal to 10 cents. Micro accounts are ideal for beginners who need to be more at ease with currency trading. While micro accounts do not allow for large positions compared to standard and mini accounts, traders can still follow sound risk management strategies without putting large amounts of their funds on the line.
Determining which type of lot size to trade with is a matter of knowing how you want to make and how much you are willing to risk. Keeping your lot size within reason according to your account size will help you survive the long term.