How Lot Size Shapes Profit and Loss
Forex Spot contracts can be traded using different nominal values, expressed in the currency placed in the denominator. For example, when a trader buys 100,000 EUR/USD, the profit or loss is expressed in US dollars (USD) at the time the transaction closes. The broker then proceeds with the conversion of the amount expressed in dollars into the account's denomination currency. If the trading account is in euros, the broker converts the amount earned or lost from dollars to euros, taking into account the exchange rate value at the time the market position was closed.
Contracts can be expressed in various ways. The size of the transaction can be traded based on three different types of contracts:
- standard lot, starting from a nominal value of 100,000 (size 1.00)
- mini-lot, starting from a nominal value of 10,000 (size 0.1)
- micro-lot, starting from a nominal value of 1,000 (size 0.01)
Trading a standard lot means taking a position in the market with 10 mini-lots of 10,000 or 100 micro-lots of 1,000. Trading a mini-lot is equivalent to entering the market with 10 micro-lots of 1,000. Thanks to the brokers' offer on mini and micro-lots, a Forex Trader has the opportunity to enter the market by better assessing their risk tolerance level, thus exposing themselves with a lower leverage. In the past, however, it was only possible to trade standard contracts, which did not easily open the doors to small private traders.
Pip Value Across Standard, Mini, and Micro Lots
Profits and losses are expressed taking into account the value of forex pips, i.e., the PIP (Percentage in point), the smallest possible price change on an exchange rate between the current value and the immediately following one, both upward and downward. The value of the PIP depends on the size of the transaction, i.e., the nominal value traded (standard lot, mini-lot, micro-lot). For a wider look at pips within overall market fundamentals, see forex market basics and fundamentals. Consider, for example, how the pip value is expressed on EUR/USD, across the different tradable lots:
STANDARD CONTRACT
Exchange rate = EUR/USD; nominal value = 100,000; size = 1.00; pip value: 10 USD
MINI-LOT
Exchange rate = EUR/USD; nominal value = 10,000; size = 0.1; pip value: 1 USD
MICRO-LOT
Exchange rate = EUR/USD; nominal value = 1,000; size: 0.01; pip value: 0.1 USD
Bid, Ask, and Closing a Position Correctly
When trading an exchange rate, the broker provides two prices: one for buying (on the offer side, "ask") and another for selling (on the demand side, "bid"). To close, instead, a trade already present in the portfolio, it is necessary to click on the "close operation" button from the already active position. A trader who is long on EUR/USD and intends to close the trade should not simply click the "sell" button, since that only results in going short on the exchange instead of closing the position. Therefore, it is necessary to pay attention to these things to avoid confusion and opening unplanned positions in the market. For how these mechanics apply on a different instrument, see the mechanics of spot gold trading.
On Forex, there is no trading book because the market is so liquid that any bid or ask proposal would certainly find a buyer or a seller. Thus, only a mask with a price for buying and one for selling is displayed. The deep book with multiple levels is, instead, offered by ECN brokers that allow direct access to the interbank market. The distance between the bid and the ask is called the spread, which generally represents the earnings of brokers who also work as counterparties in transactions. The spread is very low on major exchange rates, such as EUR/USD, USD/JPY, and GBP/USD, while it is very high on minor or exotic exchange rates. For more on this question, see the same spread for everyone.
