What it means
In currency trading, positions are bought and sold in fixed blocks called lots. A standard lot is 100,000 units of the base currency, which is the first currency in a pair such as EUR/USD.
A mini lot is 10,000 units and a micro lot is 1,000 units. The size of a lot determines how much money changes hands for each price movement.
Currency prices move in tiny steps called pips, and for most pairs a pip is 0.0001. For a pair quoted in dollars, one pip on a standard lot is worth $10, so a 50-pip move changes the value of the position by $500.
Businesses and traders use lot size to control risk. A corporate treasurer hedging a $1 million exposure might trade ten standard lots, while a small trader may use micro lots to keep each trade's potential loss to a manageable size.
Because forex is often traded with borrowed money, a standard lot can be very large compared with the cash in the account. That leads to the key nuance, which is leverage.
A broker may require only a small deposit, called margin, to hold a standard lot, so a modest price move can produce large gains or losses compared with the deposit. A trader who buys too many lots for the size of the account can lose the whole deposit very quickly.
Different markets also use the word lot differently. In stock trading, a round lot is traditionally 100 shares, and futures contracts have their own sizes set by the exchange.
Always check the contract specification, because the size and value of a lot vary with the instrument. For managers, the lesson is to translate lots into dollar exposure before trading.
Multiply the number of lots by the lot size and by the price to see the real amount at risk, then compare that with limits set by the company's treasury policy. This simple check prevents unpleasant surprises.
In practice
Real-world examples.
Example
A currency trader buys one standard lot of EUR/USD and the price moves 30 pips in her favour. She earns 30 x $10 = $300. She sets a stop-loss at 20 pips, limiting her loss to $200.
Example
An importer owes a supplier 500,000 euros in two months and decides to hedge. Her bank sells her five standard lots of EUR/USD in a forward contract. The hedge fixes her cost in dollars regardless of how the rate moves.
Example
A beginner opens a practice account and trades micro lots of 1,000 units. A 50-pip move earns him only $0.10 per pip, or $5 in total. He learns how the market behaves before risking larger amounts.
Formula
Calculation
Pip value for a pair quoted in dollars = Lot size x Pip size
Profit = Number of pips moved x Pip value x Number of lots
For one standard lot of EUR/USD, the pip value is 100,000 x 0.0001 = $10. Suppose a trader buys one standard lot at 1.1000 and the price rises to 1.1050. The move is 1.1050 - 1.1000 = 0.0050, which is 50 pips. The profit is 50 x $10 x 1 = $500. The position's total value at the purchase price was 100,000 x 1.1000 = $110,000, so the $500 gain is about 0.45% of the position.Case study
Seen in the real world.
Tidewater Imports is a fictional company that buys goods from overseas suppliers and pays in euros. Its treasurer, Hana, is responsible for an illustrative hedging policy that limits the company's currency exposure. This is a fictional scenario, not a real firm.
Hana worked out that a typical monthly payment of 300,000 euros equals three standard lots. She hedged two lots in advance and left one open to avoid being over-hedged if orders fell. When the euro rose 100 pips the next month, the hedged portion saved the company about $2,000 compared with buying at the new rate.
Watch out
Common mistakes.
- Thinking a standard lot is $100,000. It is 100,000 units of the base currency, so the dollar value depends on the exchange rate.
- Ignoring leverage. A small deposit can control a standard lot, but losses are measured against the full position size.
- Assuming the pip value is always $10. It depends on the pair and the currency in which the account is held.
Questions
People also ask.
How big is a mini lot?
A mini lot is 10,000 units of the base currency, one tenth of a standard lot.
How much is a pip worth on a standard lot?
For most pairs quoted in dollars, one pip on a standard lot is worth $10.
Is a standard lot the same in every market?
No, stocks and futures have their own contract sizes, so check the specification for each instrument.
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