Summary
- Lot size is the unit of measurement to determine how much a trader wants to trade.
- 1 Standard lot is 100,000 units.
- If USD is the quote currency (at the back), 1pip per 1 standard lot = 10USD
- If USD is NOT the quote currency, the value of 1pip per 1 standard lot will differ based on currency pair and price
- Leverage is the reason how retail traders can trade with a smaller capital.
- Leverage works hand in hand with margin
- Leverage is a double-edged sword, it can maximize your profit, likewise your losses.
Definition
A "lot" is a unit for measuring trading amount. For example, 1 lot of London gold is 100 ounces, and 1 lot in FOREX trading represents 100,000 base currency instead of 100,000 dollars.
If your base currency is the US dollar, 1 lot represents USD100,000; if your base currency is the Euro, 1 lot means EUR100,000.
Some brokers show quantity in lots while others show the actual currency unit
The change in a currency value relative to another is measure in terms of "pips", which is a very very small percentage of a unit of currency's value. To utilize this minute change in value, the trader will need to trade large amounts of currency to see significant change in profit or loss
Example; EUR/USD
For currencies with USD as quote currencies; 1 standard lot of trading volume, every 1 pip of change in the currency will result in a USD10 change
EUR/USD
Trading Volume | Currency Price | Change in Pip | Profit/Loss in Currency |
1 Lot(100,000 EUR) | 1.38869 | 1.38879(change of 1pip) | 10USD |
Example; Currency pairs that are not quoted against USD; USD/JPY or EUR/GBP, the formula will differ.
Currency Pair | Currency Closing Price | PIP Value Per | ||||
|---|---|---|---|---|---|---|
1 Unit | Standard Lot | Mini Lot | Micro Lot | Nano Lot | ||
EUR/USD | Any | $0.0001 | $10 | $1 | $0.1 | $0.01 |
USD/JPY | 1USD = 80JPY | $0.000125 | $12.5 | $1.25 | $0.125 | $0.0125 |
This begs the question;
How is it that every retail investor have hundreds of thousands to be trading?
The answer to that is Leverage, and this is how it works.
Leverage
Think of the broker as a bank who fronts you for $100,000 to buy currencies. In return, the bank requires you come up with a $1,000 deposit, which the broker will hold for you but not necessarily keep.
The amount of deposit, otherwise known as "margin" will depend on the broker that you're comfortable using.
Once you have deposited your money, you will then be able to trade. The broker will also specify how much margin is required per position (lot) traded.
For example, if the allowed leverage is 100:1 (or 1% of position required), and you wanted to trade a position worth $100,000, but you only have $5,000 in your account.
No problem as your broker would set aside $1,000 as a deposit and let you “borrow” the rest.
Of course, any losses or gains will be deducted or added to the remaining cash balance in your account.
The minimum security (margin) for each lot will vary from broker to broker.
In the example above, the broker required a 1% margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit on the position.
Let’s say you want to buy 1 standard lot (100,000) of USD/JPY. If your account is allowed 100:1 leverage, you will have to put up $1,000 as margin.
The $1,000 is NOT a fee, it’s a deposit.
You get it back when you close your trade.
The reason the broker requires the deposit is that while the trade is open, there’s the risk that you could lose money on the position!
Assuming that this USD/JPY trade is the only position you have open in your account, you would have to maintain your account’s equity (absolute value of your trading account) of at least $1,000 at all times in order to be allowed to keep the trade open.If USD/JPY plummets and your trading losses cause your account equity to fall below $1,000, the broker’s system would automatically close out your trade to prevent further losses.
This is a safety mechanism to prevent your account balance from going negative.
