In this article, we’ll focus on what a Trading lot is and how to correctly determine the value of a trade on a trading platform. Remember that when you start your trading adventure, you may encounter a multitude of words that you have never heard before. These can be simple terms like trading account or trader calculator, as well as more sophisticated terms like pips, Trading lot, leverage or swaps. It’s natural that when you hear a word you don’t understand you want to raise your hand and start asking a questions. Let’s start.
What is a lot and how to calculate it?
The basic trading unit on the foreign exchange market is 1 Trading lot. It means 100,000 units of the base currency. It is a standard size on the retails currency market and thanks to the lot size, even the low price movements the difference between the purchase price and the close price can satisfy even demanding traders.
What is the meaning of the term “currency pairs”? What do they really represent? The base currency is the first currency in a pair and the quoted currency is the second currency in a pair. The currency pair shows how much of the quoted currency must be spent in order to purchase one unit of the base currency. The example of a 1.1700 Euro to US dollar (EUR/USD) means nothing more than that 1.17 USD has to be spent to get one EUR.
Taking a position on the most commonly traded currency pair in the world – EURUSD (Euro to US Dollar) of 1 lot will mean that you’re opening trade of 100,000 EUR and the result will be settled in USD. Buying EURUSD means that EUR was bought and it the same time USD was sold. In turn, selling EURUSD means that EUR was sold when USD was bought. Buying one currency always involves selling another currency, which justifies the existence of currency pairs in the market.
Knowing how much a trading lot is, it is worth sharing what leverage on the trading market is. Trading leverage is a mechanism that allows you to take a larger position than you would normally be able to open with your funds on your trading account. Trading leverage is a huge advantage of this market over traditional cash markets as they do not offer any leverage.
Leverage in the trading market means how many times your market position can exceed the funds you deposited on your trading account. If you trade with the trading leverage of 1:100, it means that having deposited 1000 USD, you’re gonna be able to trade with the position 100 times bigger, that is 100,000 USD. If you deposit the same amount of 100 USD but you increase the leverage on your trading account to 1:200, you’re gonna be able to trade with the capital of 200,000 USD. If the broker offers you even higher leverage, for example, 1:500, you’re gonna be able to open positions up to 500,000 USD.
What high trading leverage offers you? Potential of gaining extraordinary returns in a short period of time. To give you an example, if you operate with 1:500 leverage and 1000 EUR on your trading account, you’re able to open a maximum position of 5 lots and EURUSD (Euro versus US dollar). If you buy 5 lots on EURUSD and it goes up by 100 pips you’re gonna immediately earn 500 pips that are worth 5,000 USD. In other words, you’re gonna make 500% of the capital invested.
Lot, mini-lot and micro-lot
Currency market offers you great trading opportunities and you’re not forced to open positions which are always equal to 1 lot. Depending on the broker and the type of account, you as a trader can take positions from a full lot (1 trading lot) up to 0.1 lot (mini trading lot) or 0.01 lot (micro trading lot). For example, you can open a position of 0.17 lot or 1.59 lot – it all depends on you and your trading system.
To give you a better overview of how flexible the currency market is, let’s focus on the capital which is required to trade small positions. For example, by taking a position of a micro lot, 0.01 lot you’ll require to have on your trading account capital 100 times smaller compared to what you would need to have when trading a standard lot 1.00 lot This is a particularly good solution for investors who do not have significant initial capital and want to spend their modest contribution on the possibility of multiplying their capital in the currency market. Thanks to this, the FX market is open to a multitude of different traders.