All forex traders will admit that they found lot size a confusing issue when they first started trading. It is more complicated than other markets. However, with the explanation below you will soon be able to calculate the correct lot size with ease.
This article shows how to calculate your lot size in order to risk a fixed amount. You can also download a Free Spreadsheet that will do the calculations for you.
In order to get to lot size it is important to be clear on the useful terminology.
Base and Quote Currency
Forex pairs are always made up of 2 currencies. In the EUR/USD pair, the base currency is Euros and the quote currency is US Dollars.
What are Pips and Lots?
Currency pairs are divided into pips (percentage in point). For most currency pairs a pip is a movement of 0.0001. The exception is the Japanese Yen where 1 pip is a movement of 0.01.
Position sizing is in lots. 1 lot is equivalent to a movement of 10 of the quote currency. 1 mini lot (0.1) is equivalent to a movement of 1 of the quote currency. Many traders these days tend to trade using positions sized in mini-lots because it gives more flexibility.
Your Trading Account Currency Matters
The majority of traders around the world have trading accounts denominated in US dollars. If your trading account is in US dollars it is easy to work out the value of many of the most widely traded pairs. For EUR/USD, GBP/USD, AUD/USD and NZD/USD , a position size of 1 mini-lot is always equivalent to $1 per pip. This is because the quote currency is the same as your account currency.
EUR/USD: 100 pip gain = US $100 profit
For other pairs such as USD/JPY, USD/CAD and EUR/GBP your profit will be denominated in the quote currency. If you are trading 1 mini-lot of USD/CAD the position size is equivalent to CAD $1 per pip.
To find out your profit in US dollars you need to divide by the prevailing USD/CAD price. The following example assumes the USD/CAD is 1.3200.
USD/CAD: 100 pip gain = CAD $100 profit
Total profit is US dollars: 100 / 1.32 = US $75.76
How to Calculate the Correct Lot Size
If you want to enter as USD/CAD trade that will risk US $1 per pip then you simply need to adjust the number of lots by the USD/CAD price. Assuming again that the current USD/CAD price is 1.3200.
Lot size: 0.1 * 1.32 = 0.13
Example: Trading the EUR/GBP
In this example you want to enter a trade on the EUR/GBP with a trading account denominated in US dollars. You want to set a stop-loss of 100 pips and want to risk $200 if the stop-loss is hit. The current price of the GBP/USD pair is 1.2200.
If your trading account was denominated in GB £ then you would enter a lot size of 0.2. This is a risk of £2 per pip. In order to convert this into your US $ denominated account you need to adjust this by the current GBP/USD price:
Lot size: 0.2 / 1.22 = 0.16
To make things even easier I have created a free spreadsheet that does that calculations for a US dollar denominated account. The spreadsheet is designed for a fixed fractional position sizing system. It also includes the calculation for the ATR. To see how the spreadsheet works see the video below.
To get the free spreadsheet all you need to do is sign up to the Tradinformed Newsletter. You will receive an email about once a month about the latest article and can leave at any time. Also, if you sign up you will be able to download lots of other totally free trading resources.
Check out the video below to see the spreadsheet being demonstrated.