If considering Forex trading, one of the key decisions is to decide upon how big a trade to make. When making a trade, a number of units of any given currency are either bought or sold at the appropriate rate with the transaction being reversed to close the trade.
Forex Trading: Types of Trade
Buying a currency is referred to as a long trade while selling a currency is referred to as a short trade. The profit made or loss incurred is then a function of the fluctuation in the price of the currency multiplied by the number of units of currency bought or sold.
For example, if one where to go long on 100,000 units GBPUSD at 1.5000 and then sell at a price of 1.5100, the profit made would be 100,000 x 0.01 or £1,000. However, the difficulty for traders is that most brokers do not deal in units of currency but rather “lots”, one standard lot representing 100,000 units of currency.
As such, when placing a trade for one lot, this may seem like a small number but in fact the individual is gaining an exposure to 100,000 units of currency at a time. For many small investors, even exposure to one lot may be too risky in comparison to the size of transaction required.
As such, most brokers will allow individuals to trade in smaller units with many online brokers allowing trades as small as 0.01 lots. A simple table of exposure is given below:
- 1.0 100,000 units of exposure (One standard lot)
- 0.1 10,000 units of exposure
- 0.01 1,000 units of exposure
Forex Trading: Getting the Right Lot Size
When trading, it is essential that the right lot size is used as even a small fluctuation in the price of a currency can result in large profits or losses when multiplied by a sufficient level of exposure.
The result of misplacing a decimal by just one place will result in a risk ten times of that of the intended trade, for instance while a penny movement on a 0.1 lot trade size is £100, this becomes 1,000 if one where to enter by mistake a 1.0 lot trade size.
Selecting the appropriate lot size will depend upon the size of trade one wishes to place, larger lot sizes giving the possibility of larger gains from the same underlying movement in the security. However, equally the size of loss is increased by the same magnitude should the position turn upon the investor.
As such, the appropriate lot size will be a function of the amount of capital available to the investor and how much capital they are willing to risk on a single trade.
Frank Smith - Frank Smith currently works as an full time industry analyst for a well known construction company in Lincolnshire. In his spare time, ...
