Forex Lot Size - The Easiest Way to Limit Risk in Forex Trading

Position size is usually the easiest one to keep your maximum loss risked per trade in control and, at times, is the only one. Your forex position size is how many forex lots (micro, mini or standard) you take on a trade. Your risk is broken down into two parts--trade risk and account risk.

What is a Forex Lot and why does it matter

Obsessive focus on risk and money management, meaning keeping your risk per trade as low as possible or avoiding relatively large losses, however you phrase it, is what separates the elite long-term survivors from the majority that eventually drop out. The size of your forex positions is a key part of risk management because the smaller the lots you trade, all else being equal (leverage, number of lots, and more), the less each pip is worth.

So, smaller forex lots mean that for each percentage move in price, there’s less profit, but more importantly, less loss. It’s the losses that can wipe out your capital, your confidence, and thus your trading career. For a number of reasons based on the history of forex trading, currency pairs usually trade in standard size lots of 100,000 units of the base currency (1 forex lot). To make trading affordable to the individual trader of average means, online forex brokers invented mini accounts with lot sizes of 10,000 (1 forex mini lot), and micro-accounts with lot sizes of only 1,000 units (1 forex micro lot). We don’t just like these newfangled innovations. We love them. Because smaller forex lot sizes reduce your risk per lot traded, they give you a number of important advantages over standard lots.

forex lot size

They provide greater flexibility to adjust your forex position sizes with the circumstances:

  • When you’re hot, you can increase position size by adding forex lots.
  • While you’re learning, making the transition from forex demo accounts to real accounts, or in a losing streak, small lots help you keep losses down until your trading improves and is consistently profitable most weeks or months.
  • When you want to enter or exit a position in stages with only part of your planned position (another risk management technique), smaller lots make that easier to do while keeping the total cash risked within 1 to 3 percent of your capital.

Here's how all these elements fit together to give you the ideal forex position size, no matter what the market conditions are, what the trade setup is, or what forex strategy you're using.

Continue reading for more information or start demo trading and notice in real-time how the forex lot size influences your profit and loss. Learn how to master position size in forex trading with our online MasterClass.

forex trading masterclass

01 - Set Your Account Risk Limit per Trade

This is the most important step for determining forex lot size. Set a percentage or dollar risk limit, you'll risk on each trade. Most professional traders risk 1 to 3 percent of their account. For example, if you have a $10,000 trading account, you could risk $100 per trade if you risk 1% of your account on the trade. If your risk 2%, then you can risk $200. You can also use a fixed dollar amount, but ideally, this should be below 2% of your account. For example, you risk $150 per trade. As long as your account balance is above $7,500, then you'll be risking 2% or less. While other variables of trade may change, account risk is kept constant. Choose how much you're willing to risk on every trade, and then stick to it. Don't risk 5% on one trade, 1% on the next, and then 3% on another. If you choose 2% as your account risk limit per trade, then every trade should risk about 2%.

02 - Determine Pip Risk on Trade

You know what your maximum account risk is on each trade, now turn your attention to the trade in front of you.

Pip risk on each trade is determined by the difference between the entry point and where you place your stop loss order. The stop-loss closes out the trade if it loses a certain amount of money. This is how risk on each trade is controlled, to keep it within the account risk limit discussed above.

Each trade varies though, based on volatility or strategy. Sometimes a trade may have five pips of risk, and another trade may have 15 pips of risks. When you make a trade, consider both your entry point and your stop loss location. You want your stop loss as close to your entry point as possible, but not so close that the trade is stopped out before the move you're expecting occurs.

Once you know how far away your entry point is from your stop loss, in pips, you can calculate your ideal forex lot size for that trade.

03 - Determine the Forex Position Size

Ideal forex position size is a simple mathematical formula equal to:

  • Pips at Risk X Pip Value X Lots traded = $ at Risk

We already know the $ at Risk figure, because this is the maximum we can risk on any trade (step 1). We also know the Pips at Risk (step 2). We also know the Pip Value of each currency pair (or you can look it up).

All that leaves us to figure out is the Lots traded, which is our position size. Assume you have a $5,000 account and risk 2% of your account on each trade. You can risk up to $100, and see a trade in the EUR/USD where you want to buy at 1.3040 and place a stop loss at 1.2990. This results in 50 pips of risk.

If you trade mini lots, then each pip movement is worth $1. Therefore, taking 1 forex mini lot position will result in a risk of $50. But you can risk $100, so you can take a position of 2 mini lots. If you lose 50 pips on a 2 forex mini lot position, you'll have lost $100. This is your exact account risk tolerance; therefore the position size is precisely calibrated to your forex account size and the specifications of the trade. You can plug in any numbers into the formula to get your ideal position size (in lots). The number of lots the formula produces is linked to the pip value inputted into the formula.

source: Forex Trading MasterClass

Final Words

Proper forex position sizing is key. Establish a set percentage you'll risk each trade; 1 to 3 percent is recommended. Then note your pip risk on each trade. Based on account risk and pip risk you can determine your position size in forex lots.

The smaller the forex lot size, the lower the risk because we reduce the following:

  • The value of each forex pip.
  • The cost of each 1 percent moves against you.

The potential loss if your stop-loss order is hit. We measure risk not by the total position size but by the potential loss if your stop order is hit.

Yes, smaller position sizes mean lower profits when prices move in your favor, with lower interest income from carry-trading. However, the priority is to keep losses low. Always. As a given percent loss requires a larger percent gain to recover your loss because you’re trading from a reduced capital base. Once you find the right combination of trading styles, instruments, and technical analysis that suits you, you will have time to increase lot size, risk, and profit potential. Until you’re consistently profitable over many months (regardless of your percentage of winning trades), the priority is to keep risk and losses on any given trade to within 1– to 3 percent of your account size. Profiting with only a minority of winning trades is okay, because many profitable traders succeed that way, as discussed in the Forex Trading MasterClass.

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Understanding what is 1 forex lot size is important, but if you want some help, MetaTrader 5 AM Broker offers a useful Forex Lot Size Calculator. Start trading and notice how 1 forex lot influence your profit and loss. 

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Categories:  Forex