What are Lots and Leverage?

Lots and leverage are concepts that will appear on day one of your Forex trading career.

What is a Lot?

A lot is the amount of a currency traded and it represents the size of the position. In the stock market, trade volume is measured in shares, and on the options market, contracts are purchased.

When opening a trade, the position size needs to be set, and only your trading account balance and leverage available will determine the maximum position size you can use.

Lot sizes are divided into three main categories:

Micro Lots

A micro lot is 1,000 units of the base currency and is usually the smallest position size you can trade with. If you trade one micro lot of the EUR/USD, the pip value is always $0.10.

Mini Lots

A mini lot is 10,000 units of the base currency. If you trade one mini lot of the EUR/USD, the pip value is always $1.

Standard Lots

A standard lot is 100,000 units of the base currency. If you trade one standard lot of the EUR/USD, the pip value is always $10.

How to Calculate the Correct Lot size?

Suppose you want to enter a trade on the EUR/USD with a stop loss of 100 pips. And let’s say you can afford to risk $20 on this trade. How would you calculate the correct lot size to achieve this? Here are the steps:

1. Divide the amount you want to risk by the number of pips you’re setting your stop loss at: $20/100 pips = $0.20 per pip.
2. Divide this value per pip ($0.20) by the pip value of a micro lot on the EUR/USD ($0.10):

$0.20/$0.10 = 2. This is the number of micro lots you need trade. 2 micro lots can also be written as 0.02 lots.

To perform this second and final step, it is important to know how to calculate the micro lot pip value of the specific currency pair you’re trading because the pip values of different currency pairs can differ. To find out exactly how to calculate pip values, please take a look at ‘What is a Pip?’.

Let’s test our calculation:

The pip value of 0.02 lots is $0.20 per pip. The number of pips at risk is 100. Multiply the number of pips (100) by the pip value ($0.20) and you get $20, which is the correct amount you want to risk.

What is Leverage?

Using leverage means that you borrow capital from your forex broker or a connected third party, with which you can open much larger trades than which you would have been able to open without access to any leverage. The forex market is generally much less volatile than, for example, stock markets.

Currency pairs can take days and even weeks to move just a couple of per cent. This means that without using leverage, it is unlikely that you will make a good return on your investment in a relatively short period of time. First of all, a large part or all of your capital will be tied up in a position (or positions) that will probably not move fast enough to satisfy your expectations of a good return. And, of course, there is a chance that the market will not move in the direction you anticipated.

As a simple example, if you have access to a $300 trading account with 1:500 leverage, you can easily open 5 trades on the USD/CAD of 1 micro lot each. Without any leverage, these trades would require capital of $5,000 because that is their combined notional value. However, with 1:500 leverage, only $10 of your $300 account would be reserved as a type of deposit to open these 5 trades and keep them open. Of course, there is usually at least a small floating loss during the lifetime of any trade. A floating loss will occupy additional capital in your trading account (besides the $10 used for the initial opening of the trades).

Leverage increases both profit potential and risk considerably. To learn more about leverage and how a margin forex trading account works, please read ‘What is Equity and Margin?’