In Forex trading, lot is used to describe the amount a Forex trader is actually trading at any given time. In simpler terms, lot refers to the size of the trade. To be able to understand what lot is in forex trading, we need to take a step back in history. A few decades ago, Forex brokers used to offer one contract size only i.e. 100,000 units of currency. That was the basic standard hence the name standard lot. Over the years, technological advancements and lower transaction costs made it easier for Forex brokers to offer lower contract sizes hence the birth of smaller lot sizes such as mini lots and micro lots which refer to contract sizes of 10,000 and 1,000 units of currency respectively.
Types of lot sizes
There are three main types of lot sizes namely; the standard lot, mini lot and micro lot. Below is a brief discussion of each of these lot types:
1. Micro lot
As the name suggests, a micro lot is equivalent to 1/100th of a standard lot i.e. 1/100 x 100,000 units = 1,000 units of currency or simply, 1,000 units of the base currency which is the 1st currency in any currency pair.
For instance, if you have a currency pair such as the EUR/USD, the base currency is the EUR i.e. the currency you are buying. The other currency (the USD in our case) is the quote currency i.e. the currency you are selling. The price displayed is usually the quote currency. If for instance the EUR/USD is quoted as 1.1400, to buy 1 EUR, you need to pay $1.14.
In our case, you will be trading with 1,000 EUROS if you are trading the EUR/USD with one micro lot. Although it is possible to trade with a smaller lot known as the nano lot which is simply 100 units of the base currency, most Forex brokers allow micro lot trades and above.
Micro lot trades allow new traders to participate in the market without having to start with a lot of capital. A micro lot will also reduce the overall exposure of a new trader allowing them to learn trading with little risk.
When trading with one micro lot, 1 pip movement is equivalent to $0.1.
2. Mini lot
A mini lot is equivalent to 1/10 of a standard lot i.e. 1/10 x 100,000 units = 10,000 units of currency. When trading one mini lot, 1 pip movement is equivalent to $1. A mini lot is simply 10 times the size of a micro lot. Although it is possible to trade a mini lot with little capital, it is advisable to have at least $1,000 in your trading account before you attempt to trade a mini lot. If you plan to trade two mini lots simultaneously, you should have at least $2,000 in your trading account and so on.
3. Standard lot
As mentioned above, a standard lot is equivalent to 100,000 units of currency. When trading one standard lot, 1 pip movement is equivalent to $10. You should trade with standard lots when you become a professional trader because standard lots are accompanied by large swings of losses and gains. Before you trade one standard lot, you should have at least $10,000 in your trading account. If you plan to trade two standard lots, you should have at least $20,000 etc.
The above information answers the question; what is lot in Forex trading. A lot simply refers to the size of a trade. The standard lot is the biggest lot size while the nano lot is the smallest lot size. You should trade lots depending on your expertise as well as the size of your capital. Trading with large lot sizes or many lots exposes you to a higher risk-reward ratio.