It may seem a little confusing at first but really, it is quite simple. Forex is a leveraged financial instrument, as is Options, Futures, CFDs, Warrants etc.

You trade Forex in ‘lots’. That is basically the industry standard, but there are brokers out there that do things slightly different. For example, Oanda trades in ‘units’, but they can be easily converted to a lot size equivalent.

Lots are known by different names, depending on how much currency they represent. There is a standard lot, a mini lot and a micro lot:

One standard lot

100,000 units of the base currency and is normally expressed as 1.0 lot

One mini lot  

10,000 units of the base currency and is normally expressed as 0.1 lot

One micro lot  

1,000 units of the base currency and is normally expressed as 0.01 lot

How many lots you can buy or sell depends on:

• your account balance;
• your nominated trading leverage;
• how much you are willing to risk on the trade.

Now I will introduce the words ‘margin’, ‘leverage’ and ‘risk’.

Margin refers to the money you have in your account that is available to trade with. As stated earlier, Forex is a leveraged instrument, so if your broker offers you 100:1 leverage, then for every 1 unit you have in your trading account, you can control 100 units in a trade. Some brokers offer up to 1000:1 leverage. If you are over leveraged and a trade goes against you, and you decide not to take any action, your broker will close the trade on your behalf to protect their interests, even though you may have blown your account out. The higher the leverage, the more currencies you can control (buy or sell more). It is not something that concerns me as my risk is controlled on all trades. Risk refers to what you are willing to risk on any particular trade, in terms of dollars (or percentage of account balance/equity).

Lot Size and Equivalent Pip Value  

Just to refresh your memory, if the EUR/USD moved from 1.1024 to 1.1028, it has moved a total of 4 pips, and if the USD/JPY moved from 109.23 to 109.19, it also moved 4 pips. Straightforward, so far.

If I was trading 1 standard lot ($100,000), then each pip is worth US $10. So, in the above EUR/USD example of the 4 pip move and assuming you were trading 1 standard lot, 4 pips is equal to US $40. The same US $10 per pip also applies to the GBP/USD, AUD/USD and NZD/USD.

That is the easy part. Now all the other forex pairs aren’t quite as simple as the USD is not the quote or counter currency. So what you have to consider here, is the currency conversion between the two pairs and the math can be a little confusing. I’ll keep it simple, and consider all pairs to have a 1 pip value of US $10 on a standard lot. Just about all of the forex pairs, except the EUR/GBP have a pip value of less than US $10, and most of these are just under that level, but they do fluctuate with currency variations. If you do need to know the exact pip value, there are plenty of free websites with a built in calculator to do the math for you.

The majority of traders either trade standard lots or mini lots. As stated previously, Oanda is slightly different here as they trade in units on their web based platform, which can be very useful for precise money management.

So, if 1 pip is equal to US $10 on a standard lot (1.0 lot / $100,000), then 1 pip on a mini lot (0.1 lot / $10,000) must be equal to US $1, and 1 pip on a micro lot (0.01 lot / $1,000) is worth $0.10. Got it? And to keep it very easy and simplified, just consider every forex pair the same. I know a USD/JPY pip on a standard lot isn’t US $10, but it is close enough for me not to worry about its exact value. If your style of trading is affected by the exact price of pips on the forex pair you are trading, then you will have to use something like a dedicated forex calculator to work out the exact values. They are freely accessible by just doing a simple google search.

Let’s get into a Trade Example:  

I have $2,235 in my trading account, and I am happy to risk 2% on each trade.

I’m in my broker’s account looking at their charts and I see a nice set up on the EUR/USD where I am looking at buying at 1.3928. I am going to place my stop (stop loss) 30 pips below at 1.3898. So my risk on this trade is 30 pips.

Now I need to know what my position size will be, where I am risking no more than 2% of my overall account balance of $2,235. This actually equates to $44.70.

The easy way to work this out is by using the following:

Account Balance multiplied by risk percentage, divided by risk (stop size in pips), equals position size.

In this trade, the math would look something like this:

$2,235 x 2% = $44.70

$44.70 / 30 pips = 1.49

Therefore, my position size on this trade would be 1.49 mini lots (0.149 lots). You would have to round this down to either 1 mini lot (0.1 lot), or 1.4 mini lots (0.14 lots) if your platform allows this trading size.

If you are unsure of the position size, whether it is in standard or mini lots, just do the math backwards to confirm. You know the maximum risk is $44.70 on this trade. If you went into the trade with 1 mini lot, you know each pip is worth $1, so if you were stopped out, then you would have lost $30, which is under your max risk of $44.70, due to the fact you had rounded your position size down.

Here is another example with a much larger account balance and a different risk percentage and stop placement.

Account balance is $37,840

Your trade risk is 3%, and

You are placing an order to sell the GBP/USD at 1.4562 with a stop at 1.4607, which is 45 pips away.

Let’s do the math to work out my position size:

$37,840 (Account balance) x 3% (risk percentage) = $1135.20

$1135.20 (max risk) divided by 45 (stop) = 25.226′

Therefore, my position size would be 25.226′ mini lots (2.5226 lots), or rounded down to 25.2 mini lots (2.52 lots) which is basically 2.5 standard lots.

Do the math in reverse if you want to double check your position size. You know your max risk is $1135.20, and your stop is 45 pips, and each pip is worth $10 on a standard lot. If you were to lose 45 pips with 2.5 lots, then 45 x 2.5 x 10 = 1125, which is under the $1135.20 risk.

It may be a little confusing at first, but it is very simple once you get the hang of it. By using this formula, you should never have to worry about leverage, margin or risk. They just don’t come into it. But having said that, it all depends on your risk percentage levels and your actual trading methods. You do need a successful trading method, because if you don’t and you were only risking say 2% per trade, you will eventually blow out your account. It will just take a bit longer to achieve this than if you were risking 10% on each trade.

There are plenty of freely available spreadsheets that can do the math for you once you plug in your own figures. These are quite handy and ensure you get the figures correct.