An important difference between the stock and commodity markets versus the forex market involves the manner in which trades are sized.
Instead of shares of stock or bushels of grain, forex transactions need to specify the amount of currency involved.
What are Lots?
Lots are the minimum transaction size in a market, and futures markets such as the Chicago IMM specify lot sizes for each traded product, including for currency futures.
Although trading in the Interbank forex market generally does not involve lots since virtually any transaction size can be executed, retail forex brokers have introduced the concept of lots to their forex trading clients.
Like in the currency futures market, these lots consist of minimum currency amounts that can be traded depending on the type of account you set up.
Generally, three basic lot sizes exist in common usage in the retail forex market. These are standard, mini and micro lots, and each is made up of a different amount of base currency. These lot sizes will be described in greater detail below.
A standard lot in the forex market typically consists of 100,000 units of the base currency for a currency pair. Therefore, a standard lot forex trading account would theoretically need to be funded with 100,000 units of base currency to exchange it for an equivalent amount of another currency in a forex transaction.
Furthermore, the funding of the account can usually be done in a variety of currencies including the Euro or Sterling depending on the forex broker.
Nevertheless, the standard lot can generally be traded with a much lower amount of money in the forex account depending on the margin and the leverage that the broker is willing to extend to their customers.
For example, using a standard lot size of 100,000 Euros would have its minimum fluctuation of one pip or 0.0001 worth $10 USD for the EUR/USD currency pair.
Mini lots usually consist of forex trading units which are one tenth the size of standard lots. In other words, a mini lot would consist of 10,000 units of the base currency. Trading in mini lots makes much more sense with a $1,000 account than attempting to trade a standard lot.
With the same amount of leverage and margin as the above example, a trader trading in mini lots can trade up to 10 mini lots with a $1,000 deposit. For the EUR/USD currency pair, the value of a pip on a mini lot of 10,000 Euros is just $1.
This makes taking positions in mini lots considerably less capital intensive than with trading standard lots. It also allows traders to hold positions in other currency pairs to spread the considerable risk involved in forex trading around.
As a rule, micro lots consist of lots that are one tenth the size of a mini lot, or 1,000 units of base currency.
Micro lots can be traded using higher leverage in many cases. They represent a fairly inexpensive way for a person to begin trading without the risk of losing too much money at the beginning of their trading career.
In the EUR/USD currency pair, the pip size for a 1,000 Euro micro lot is only $0.10. This provides an opportunity to trade in the forex market to less well capitalized traders.