Lot size
Most forex brokers nowadays provide up to four categories of lot size for traders, namely:
1. Standard Lot
2. Lot Mini
3. Lot Micro
4. Lot Nano
Standard lot is defined as 100 000 units of base currency. For example, if you buy 1 standard lot of EUR / USD, it means you bought 100 000 euro to the US dollar.
Lot mini defined as 10000 units of base currency. For example, if you buy 1 mini lot GBP / USD, then you buy 10,000 pounds to the US dollar.
Micro lot is defined as 1000 units of the base currency. For example, if you buy 1 lot of micro USD / CHF, meaning you buy 1000 dollars with swiss franc.
Lot nano defined as 100 units of the base currency. For example, if you buy 1 lot nano USD / CAD, meaning you buy 100 US dollars with Canadian dollars.
Lot size shrunk by a factor of 10 from the standard to mini to micro and eventually to nano. As the following table:
| Lot Size Category |
Unit Amount
|
Standard
|
100000
|
Mini
|
10000
|
Micro
|
10000
|
Nano
|
100
|
Lot Standard
If you are trading a standard lot, using the same values with the same example in the previous post, that explains how to calculate the value of a pip.
USD / CHF = 0.9235
Value pip = USD 0.000108
Pip value for a standard lot = USD 0.000108 x 100000
= USD 10.8
USD / JPY = 81.55
Value pip = USD 0.000123
Pip value for a standard lot = USD 0.000123 x 100000
= USD 12.3
AUD / USD = 1.0237
AUD pip value = 0.00009746
Pip value for a standard lot = USD 0.0001 x 100000
= USD 10
Lot Mini
If you trade a mini lot, 1 pip value will drop by a factor of 10. Using the same example above:
USD / CHF = 0.9235
Value pip = USD 0.000108
Pip value for a standard lot of USD 0.000108 x 10000 =
= USD 1.08
USD / JPY = 81.55
Value pip = USD 0.000123
Pip value for a standard lot of USD 0.000123 x 10000 =
= USD 1.23
AUD / USD = 1.0237
AUD pip value = 0.00009746
Pip value for a standard lot = USD 0.0001 x 10000
= USD 1
Likewise for a lot of micro and nano lot.
Leverage
Financial success is almost always achieved through the use of leverage. By using the leverage we can do more with fewer resources.
In the previous section, we talk about how the value of 1 pip rise dramatically when a trader to trade a standard lot or even a mini lot.
In fact, not many retail traders can spend $ 100,000 or $ 10,000 to trade one standard lot or mini.
This is where the role of foreign exchange. Simply put, foreign exchange brokerage business model is to give leverage to retailers so that they do not have to spend the entire $ 100,000 to trade one standard lot.
Let's see how it works. When forex brokers give you leverage of 100: 1, not the $ 100,000 that you need to pay, you only need to pay $ 1,000 to trade one standard lot. Sometimes this is called margin. Brokerage also call our trading account with margin accounts.
Margin basically allows a trader buys a contract without the need to mention the value of the contract in full. In this example, $ 1,000 is a margin Adana need to trade $ 100,000 on a leverage of 100: 1
By using a simple formula:
Margin required = Lot Size / Leverage
As an example:
Margin required = $ 100000/100
= $ 1,000
Percentage margin = amount of margin / lot size
= $ 1000 / $ 100,000
= 1%
Similarly, if the broker gives you a leverage of 50: 1 and not $ 100,000 but you need to pay is $ 2,000 to trade one standard lot. In this case, the margin percentage is 2%.
The higher the leverage given broker, diminishing the amount you need to pay to trade one standard lot. Here's an explanation in the table:
Margin Requirements
|
Maximum leverage
|
5%
|
20:1
|
3%
|
33:1
|
2%
|
50:1
|
1%
|
100:1
|
0.5%
|
200:1
|
0.2%
|
500:1
|
See table above, logical to conclude that we should choose the highest leverage, because it requires us to pay the least amount of money to trade standard lot.
Excessive Leverage Risk
Leverage is a double-edged sword. Although it has the potential to increase the profit a merchant, leverage also has the potential to magnify losses. In fact, as great leverage the greater the risk.
Let us observe an example:
Trader A and Trader B opened with a broker and start trading with a capital of USD 10000. Trader A using 100: 1 leverage while trader B using a 10: 1 leverage. Both traders then decided to sell the EUR / USD as the sovereign debt crisis is the ongoing pressure on the euro.
The total value of the contract trader A is 100 x $ 10,000 = $ 1 million, this equates to 10 standard lots. The total value of the contract trader B is 10 x $ 10,000 = $ 100,000, this equates to 1 standard lot.
For EUR / USD we know that the value of one pip is equal to 10USD for one standard lot. If the transaction resulted in a loss of 50 pips for them, both of these traders will suffer losses as follows:
A trader: (10 lots) x (50 pips) x ($ 10 / pip) = USD 5,000
Trader B: (1 lot) x (50 pips) x ($ 10 / pip) = USD 500
Loss of USD 5000 represent 50% of trader capital A, but lost $ 500 represents only 5% of trader capital B.
In conclusion, although leverage could potentially magnify your profits, leverage also has the power to magnify your losses. So it goes both ways.
The following table summarizes the two traders above:
Trader A
|
Trader B
|
|
Capital
|
||
Leverage
|
||
Total value of the transaction
|
||
Loss of 50 pips
|
||
% Capital loss of trade
|
||
% Residual capital of trade
|
Thus the entire explanation of part one, part two, until part three. next post is a summary, bye and thank you.
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