What Is Lot, Leverage and Profit In Forex Trading?

What is Lot in Forex trading?

As you may have noted, there are various things that all aspiring Forex traders need to understand before getting into the real business of trading Forex.

Having a deeper insight into all these aspects is one of the major factors that lead to a successful trades. Traders should, therefore, be keen to learn everything that can guarantee them a profitable trade.

Keep in mind that a successful trade, in this case, means a trade that leads to positive returns. If we were, to be honest, the main aim of getting into Forex trading is to make returns on investment.

Traders who are conversant with all the aspects of trading are more likely to make positive returns as compared to traders  who know nothing.

If you have friends who trade Forex, you may have heard them mention the term “lot” but did you understand what this is and what it has to do with Forex trading?

Whether you think you know or not, keeping reading this article will give you a more in-depth insight into what this is all about.

Defining Lot In Forex Market

By definition, lots refer to bundles of units within a trader’s trade. In simpler terms, this refers to the sizes of the trades made by Forex traders.

Let’s take a typical example here that can enhance your understanding of the same.

Consider a pack of beer. Beer is mostly sold in packs containing six bottles each. Consumers can purchase as many packs as possible (containing six beers) but can’t separate the packs.

This is the case with lots in Forex trading. Now substitute the box of beer with a bundle of currency that is allotted to each trade. I hope that you are getting to understand what this alludes to.

Usually, a lot size of 100,000 currency units is considered to be the standard lot size. There are, however, other lot sizes which are mini, micro and nano sizes.

The Nano sizes, in this case, are 10,000, 1000 and 100 units. It’s of great importance to understand this properly since you will find some brokers showing quantities in lots.

Also Read: What exactly does Forex trading sessions mean?

Understanding Pip in Forex Trading

Another essential term we need to define here is the “pip”.

In Forex trading, the value of one currency changes relative to the amount of another currency. This relative change in the number of coins is measured in pips.

Pips can be considered as the smallest percentage of units’ currencies value. Since this change in the unit currency value is minimal, traders need to trade vast amounts of a particular currency to make a significant gain or loss.

To understand this better, allow me to show you a typical example.

Consider a trader using a standard lot size (100, 000 unit).

Now let’s do some calculations here:

USD/JPY = 119.80

(0.01/119.80) multiplied by the standard lot size would be:

(0.01/119.80) x 100,000 units = $8.34 per each pip

Also,

USD/CHF =1.4555 would give 0.0001/1.4555 x 100,000 unit = $6.87 per each pip

Kindly keep in mind that if the USD is not the one quoted first, the formula changes a bit.

Let’s EURO USD for example:

EUR/USD = 1.1930 in this case we will have ( 0.0001/1.1930) x 100,000 = 8.38, then ( 8.38.X1.1930) = $9.99734 2 and this is $10 if rounded up

Likewise GBP/USD = 1.8040 would be (0.0001/1.8040) X 100,000 = 5.54 and the (5.54 x 1.8040) equals 9.99416 which is $10 per pip if rounded up.

You need to be when making these calculations since different brokers have different techniques of calculating the pip value relative to the lot sizes.

Also Read: 5 Common Forex trading mistakes you should avoid

A reliable broker will always tell you the pip values of the currencies you will be trading at a given moment. Also, note that the pip values will shift as the market shift depending on the currency being traded.

Also Read: The true concept of technical analysis trading

Leverage

When trading Forex, you might be having fewer amounts than what you would wish to invest. Your broker might decide to give you some credit so that you can make your trade.

The number provided by your broker as capital is what is referred to as leverage. This enables you to trade with more amount than you would have done with the amount in your trading account.

Take an example where you have 100:1 as the leverage, and you wish to invest $100,000 and only have $5,000.

In this case, you will need to deposit $1,000 and then you can borrow the rest from the broker.

Calculating Profit and Loss

Take an example of USD vs Swiss Francs.

The quoted rate = 1.4525/1.4530. Since you are purchasing the USD, you will need to consider the asking price, which is 1.4530. This is the rate set by traders

Buy a standard lot at 1.4530

If after sometimes the price shift to 1.4550 you may now decide to close your trade

Assume that the new USD/CHF = 1. 4550/1.4555. In this case, you will need to close the trade by selling and this means you now consider the bidding price which is 1.4550

Get the difference (1.4530-1.4550) = 0.0020 equivalent to 20 pips

Using the formula we had before (.0001/1.4550) multiply by 100,000 = $6.87 per pip multiply by 20 pips you get $137.40

Also Read: 50 fun facts about Foreign exchange industry

Bid-Ask Spread

When purchasing a currency, you should consider the ASK price and when selling, you think the bid price.

I hope that this article has sharpened your skills as far as Forex trading is concerned. Standby for the next piece.