What is a Lot in Trading?

A lot is a standard unit of measurement for an asset to be traded. It signifies the specific quantity of an asset or commodity that can be traded in the market. Most trading platforms quote order sizes in lots.

There are 4 lot sizes including Nano, Micro, Mini, and Standard. However, not all brokers offer Nano lots. Listed below are the units of currency of each lot size: 

• Standard lot:100,000 units of currency
• Mini lot: 10,000 units of currency
• Micro lot: 1,000 units of currency
• Nano lot: 100 units of currency

The variation in the size of lots can affect the margin requirements for a trade. Larger lots often require higher margin trading account deposits than smaller lots. 

What is Position Sizing? 

Position sizing is the process of determining the appropriate amount of a financial instrument to trade based on the size of your trading capital, risk tolerance, and trading strategies.  It is the size of a position within a portfolio or the dollar amount to be traded.

The trading account size often determines the maximum amount a trader can allocate to a single trade. In most cases, the larger the trading account, the bigger the position size. The risk tolerance of the trader also affects the position size. The higher the trader's risk tolerance, the larger the position size and vice versa. 

Other factors that can affect position sizing include the trading strategy being used, stop loss, and the desired risk-reward ratio. For instance, a high-frequency trading strategy that involves frequent trades often requires smaller positions. While long-term trades involving fewer trades often involve larger positions. 

There are different position sizing techniques available to traders: 

• Percentage of Account: This position sizing technique allocates a fixed percentage of your trading account balance to each position. 
• Risk-Based Sizing: This technique involves calculating your position size based on your desired risk per trade and the potential reward of the trade. The higher the position size, the higher the risk. 
• Fixed Amount: This strategy allocates a fixed amount to each position regardless of the asset or the size of your account. 
• Volatility-Based Sizing: The volatility-based strategy involves adjusting your position size based on the volatility of the asset. The higher the volatility, the smaller the position size. 

While position sizing is an effective risk management strategy, it is important to note that it can fail sometimes. This is because even with a well-defined position sizing strategy, market conditions can rapidly change and emotional reactions can still affect the trading decision. 

Also, position sizing may not accurately reflect individual risk tolerances. It is therefore best not to rely on a mechanical approach to trading using this technique as it can lead to the neglect of other important factors like personal evaluation and fundamental analysis. 

How Do You Calculate Lot Size When Trading?

Knowing how to calculate the lot size of a trade is a crucial skill for traders who want to manage their risk and position size. The calculation depends on your account size, risk tolerance, and the instrument/currency pair you’re trading. 

• Account Size: A general recommendation is that you risk no more than 1 to 2% of your account value on each trade. 
• Risk Tolerance: You must decide how much of your account you’re willing to risk on a trade. 
• Stop Loss: You need to determine your stop loss level, which is the price point at which you’ll exit a trade when the market moves against your open position. 

After determining the account factors, you can calculate the lot size to determine the right one for your trade. That said, most brokers have built-in lot size calculators that traders can use instead of manual calculations. Here’s an example of how to calculate: 

• Account size: $10,000
• Risk per trade: 1%
• Stop loss: 50 pips
• Currency pair: GBP/USD
• Price per pip: $10

The formula for calculating is Lot Size = Risk Per Trader x Account Size / Stop Loss x Price Per Pip which for our example is Lot Size = 1% x $10,000 / 50 x $10 = 0.2 lots

How Do You Calculate Position Size When Trading?

To calculate the proper position sizing for your trade (say stock trade, for example) you must consider how much you’re willing to risk per trade (risk tolerance) and the risk per share. 

Next, divide the risk per trade by the risk per share, which will give you the number of stocks/units to buy or sell. 

So if you want to buy (long position) a stock, trading at $50 and you get an entry price of the same value, with a stop loss at $40, the risk per share is $10 ($50 - $40). Hence, if you’re willing to risk $600 on this trade, the position sizing of the trade is 60 units ($600 divided by $10).

Conclusion

Understanding lots and position sizing is a fundamental skill in managing risk and optimizing positive trades. Position sizing and lot size directly impact how market price movements affect your trade account. 

Calculating the proper position size and lot size is crucial; too large and you risk exposure to massive losses, too small, and potential wins may be infinitesimal. 

So to calculate the right lot size and position sizing consider your risk tolerance, account balance, risk per share, and the specifics of the instrument/pair you’re trading. 

FAQ

Are Lot Size and Position Size the Same? 

No, forex lots are units of measurement that determine how many units you’re buying. Position sizing is determined by the number of lots you buy or sell and the lot size. 

What is a Position Size Calculator? 

A tool that allows you to calculate the size of your position in units and lots for accurate risk management. 

What is the Ideal Position Size for a Trade? 

The ideal position of a trade depends on your risk tolerance level (maximum risk) and risk per share. 

What is the Maximum Position Size?

The maximum position size is the ultimate trade size allowed (absolute value) at any given time by the broker based either on account balance or per trade.