In the world of forex trading, you may come across the term “lot” several times while trading. It refers to the measure of an increment in the value of a particular asset or product, deemed suitable for purchasing and selling. Forex traders should have a basic understanding of what a lot stands for if they ever want to make consistent profits.
Judging by the number of times people have searched for India forex trading ideal lot size, there seems to be a lot of interest among the Indian trading community to know about the ideal lot size while trading with online brokers. Before we dive into that, we will first examine what a lot is in detail.
Explaining a Lot in Forex
In forex trading, currencies are generally traded in particular lots of 100, 1000 and so on. There are mainly three types of lot sizes that brokers provide: Standard lot, mini-lot and micro-lot. A standard lot is 100,000 units of a currency, while mini and micro-lots represent 10,000 and 1,000 units respectively. A one-pip movement for a standard lot represents a change of $10.
For example, if you buy $10,00,000 against the Japanese Yen at a rate of ¥110. If the exchange rate changes to ¥110.50, it is recognised as a movement of 50 pips. You will thus make a profit of $5000. On the flip side, if the exchange rate decreased to ¥109.50, you’ll incur a loss of $5000.
The emergence of online trading platforms has increased the competition in the space, so much so that they have started providing lot sizes apart from the standard, micro and mini lots. For example, they have introduced nano lots, which represent 100 units of a currency. This allows even more small retail traders to access the forex market and take part.
The Relationship Between Leverage And Lot
Before we understand the relationship between lot and leverage, we first need to understand what leverage is. Leverage, in the simplest terms, is a financial tool, allowing traders to handle a much larger position than would be possible with the balance in their trading account. For instance, if you are using a leverage of 20:1 while you have $5000 in your account, you’ll be able to open positions worth $100,000.
Both leverage and lots are different concepts in forex. Leverage does not affect the value of a contract. In other words, the value of a standard contract or lot in a currency will be 100,000 units, no matter what leverage is used. However, leverage affects the amount of money you have at your disposal. To understand this, let’s look at how trades are calculated with or without leverage.
- Trade without leverage:= quote price*lot size* the number of lots.
- Trade with leverage= (quote price*lot size*number of lots)/leverage
So the size of the contract is proportional to the trade’s value, meaning that the trade’s value will increase if the leverage also increases. Leverage is set by the broker in the case of currency pairs.
What is margin?
In layman’s terms, margin refers to an amount of money that a trader puts forward for the privilege of opening a trade. In terms of forex trading, it is a percentage of the full value of a position that you want to take. Trading on margin enables you to increase your exposure to the market, amplifying both profits and losses.
When you open a position with an FX broker, the broker will hold your initial deposit as collateral. The amount of your funds that the broker has locked up to maintain your positions in the market is known as the used margin. More funds in your accounts will be dedicated towards used margin as you open more positions. The funds you have left to open positions any further is known as available equity, which is used to calculate margin level.
Let’s take a look at an example. You fund your account with $10k in your FX account and open 2 trades. The required margin for keeping these trades open is $2500. Here, the margin level =$(10,000/2500)*100=400%. You will have more cash to use for additional trade as the margin level gets higher. When this margin level reaches 100%, it indicates that no further trades can be placed.
What happens when your positions are in the negative?
When the trader has multiple losing positions, the margin level on that account will fall. If it falls below the 100% mark, the amount of money available in that account is no longer sufficient to cover the margin requirements of the trader. In such cases, the broker requests that the trader’s positions are liquidated, which is known as a margin call. Most good brokers have a reliable alert system to notify traders everytime they are about to receive a margin call.
Risks and Benefits of Trading With Leverage
In the forex trading world, leverage is often called a double-edged sword and for good reason. This tool can provide many advantages, only if you are aware of the disadvantages as well. Do not get easily fooled by advertisements that proclaim higher leverage equals higher payouts. The concept isn’t as easy as it appears.
Benefits of Leverage
- Leverage allows you access to additional funds by borrowing from the broker. This bridges the gap that existed between the forex market and small, retail traders.
- It frees up a lot of your capital as you are required to only commit a fraction of the total value of assets in your trades.
- Leverage allows access to many currency pairs and other assets that would otherwise be out of reach for most traders.
Risks of Leverage
- When you use leverage, you are effectively giving up the benefit of ownership in case of shares trading and delivery in case of futures trading.
- The broker can call on you to deposit a greater margin to cover your losses in case the market goes against you.
- Your losses are multiplied many times over. If you’re not careful and mindful of the funds in your account, it can wipe it out as a result of a bad trade.
What is the ideal lot size for FX trading?
There’s no single right answer to this question as it mainly depends on the currency pair you’re trading and the experience level of the trader. Keeping your lot sizes as small as possible will allow you to have more time in the forex market. A higher lot size but a small capital increases the chances of a trader ending up losing everything.
- When it comes to novice traders, they should concentrate on trading forex in mini or micro-lots. They can also go for nano lots if they think they don’t want to risk much at first. As they gain confidence, they can upgrade to the next level. Always ensure that you’ll be using stop-loss and target levels to maintain correct risk management.
- For standard or intermediary level traders, standard lots or micro lots should work fine.
- Professional traders might prefer higher lot sizes as they have more liquidity to open such positions and can thus aim for higher gains.
- For scalpers, every pip is valuable and they need the highest lot sizes available to maximise every opportunity.
Final Thoughts
It is always advised that you get your concepts clear on different aspects of trading such as technical analysis and risk management before you start trading with leverage. Understanding lot sizes is a beneficial first step in your education as a forex trader. However, you have to take the necessary steps to better analyse price action and protect yourself from unexpected profits. There are many forex brokers that Indian traders can sign up with, which provide favourable and varied lot sizes to their clients.