What Are “Lots” in Forex Trading
The decision to take a trade in the Forex market is the result of a due diligence process that must consider various factors. Knowing where the market will go is not enough to make a profit from Forex trading. There are only two directions to choose from before taking a trade: long or short. If the trader thinks the market is moving up, a long trade should be taken, if not, a short one. That’s it, nothing else regarding the potential future direction. Both fundamental and technical analysis are helping traders to find direction or the future move a currency pair is making. Is this enough, though? Are there any other factors to consider for the trade to be profitable and, if yes, how to interpret them? The right answer is that only the direction is not enough. One might be right about the direction the market is going and still, lose money on a constant basis. Let me give you an example, using the Elliott Waves theory (we’ll going to have a bunch of articles dedicated to it later in the Trading Academy), about how it is possible to lose money even if you know the general direction the market is moving to. The timeframe used is most of the times the reason for the wrong interpretation of an outcome. Greed and fear play tricks on us and it is either making traders taking unnecessary risks, like overtrading, or closing positions too early, due to fear of being stopped out or losing the trading account. In both cases, the volume traded holds the key to avoiding losing your account or avoid overtrading. In terms of the Forex market, volume equals lots.
Volume is expressed in lots, so the number of lots one trades is directly proportional to the risk associated with that trade. The bigger the volume traded, the bigger the risk, but also the bigger the potential reward. Therefore, traders need to find the right balance between the volume to be traded, or the lots number, and the size of the account. Balancing these two is part of a sound money management system that should be followed by all traders, no matter the financial product traded.
|Forex Review & Rating||Highlights||Regulation||Min. Deposit||Bonus||Visit Broker|
|Xtrade review||Next-generation online CFD trading platform||CYSEC||$100||60%*||Trade!|
|XM review||$1,000,000 Forex Championship at XM||CYSEC||$5||100%*||Trade!|
|AvaTrade review||+250 instruments – forex, CFDs for stocks, commodities & indices||MIFID||$100||40%*||Trade!|
A standard lot in the Forex industry is the equivalent of $10/pip (if the trading account is denominated in USD) for the EURUSD pair. For more about what is a pip, please refer to one of the previous articles here on the Trading Academy, as we’ve treated that subject in details. Therefore, if one lot is traded on the EURUSD pair and the pair moves in your favor ten pips, a profit of $100 is realized, before any other expenses in that trading account (commissions, spreads, swaps, etc.). On the other hand, if the trade goes against the desired direction, the loss is -$100. The image below shows one lot sold for the EURUSD pair, at the market, right at the moment this article is written. Consider that this is a demo account and the potential gain or loss is virtual.
A simple look at the balance and equity of the account, it is telling us that trading one lot on this account size is not wise. It means that if the EURUSD pair is moving against the trade for one hundred pips, namely if it moves to 1.0818, the trading account takes a $1000 hit. This is more than ten percent of only one trade, and it means one thing: the account is overtraded. Again, the thing to do is to find the right balance between the size of the trading account and the volume that is traded. As mentioned in the previous articles, it is not possible to have only winning trades, as that is not a realistic expectation when trading Forex. The idea is to have more winners than losers and in time the account to grow. One hundred pips moves or even a few hundred pips moves can happen in a blink of an eye, and this means that to trade one standard lot, the account size should be bigger than the one illustrated here. After all, it is only logic.
Forex brokers that offer traders access to the market know that not all retail traders can deposit large funds in a trading account. The amount deposited are quite small. Therefore, it is not possible to trade one standard lot, and the need for a new product appeared. This new product consists of offering retail traders the possibility to trade fractional lots. What is a fractional lot? This represents trading volume smaller than one standard lot and it is offered by all brokers these days.
As it can be seen in the image above, below the one standard lot, there are fractional lots or quantities available to trade, like 0.12, and so on. Those are only default ones, but traders can pick 0.25 or 0.33 or whatever the single digit number can be. This way, trading with a smaller account is not that risky anymore and money management techniques can be applied to small trading accounts as well. Chances to survive in the ever-changing Forex environment just became bigger!
Believe it or not, for Forex brokers, quantity is better than quality. Brokers are competing for bringing more and more new customers and convincing them to trade. For that, they need to offer conditions to attract them. After all, what is the difference between ten customers that deposit $10000 and one hundred customers that deposit one hundred dollars each? The right answer is that there is no difference, only that the ones with small deposits cannot trade standard or fractional lots. To overcome that, micro-lots have been invented. This is a further subdivision of fractional lots, and a typical volume for a micro-lot trade can be 0.05, or 0.01. This means that for every EURUSD pip move on a 0.05 or 0.01 micro-lot trade, the trader loses or gains fifty cents or ten cents. While the risk is lowered, the potential gains are lower as well. However, trading with micro-lots has multiple advantages, like allowing traders to get the real feeling behind a live trading account and, with perseverance, in time, the account can grow. The purpose of this article is to show the importance of the volume traded, and this is measured in lots or lots subdivisions. Volume has a saying in the size of the commissions to be paid as well, and all these details, while they look like being insignificant, matter for the overall trading strategy. Traders should use different volume sizes based on the funds available in the trading account if they are to stand a chance against Forex volatility. For that, adjusting the lot size is key.
Recommended Further Readings
- Why Trading with a Regulated Forex Broker?
– What is regulation for a brokerage house, why it is important, things to look for, how to check if the broker is telling the truth, etc.
- Benefits of Mobile Forex Trading
– Pros and Cons of mobile trading, highlighting the net benefits of it.
- Explaining Commissions in Forex Trading
– What type of Forex trading accounts are subject to paying commissions, what does it means and is this a good or a bad thing?
- Opening a Live Trading Account
– Steps to open a live trading account with a Forex broker, starting with the time taken for the whole process, documentation to be sent, verification process, trading platforms to download, etc.
- ANN for FOREX forecasting and trading. Czekalski, P., Niezabitowski, M. and Styblinski, R., 2015, May. In Control Systems and Computer Science (CSCS), 2015 20th International Conference on (pp. 322-328). IEEE.
- “Comparative study of FOREX trading systems built with SVR+ GHSOM and genetic algorithms optimization of technical indicators.” de Brito, Rodrigo FB, and Adriano LI Oliveira. In Tools with Artificial Intelligence (ICTAI), 2012 IEEE 24th International Conference on, vol. 1, pp. 351-358. IEEE, 2012.