What Is Equity in Forex Trading?

What Is Equity in Forex Trading?

What Is Equity in Forex Trading?

What Is Equity in Forex Trading?

There are many concepts in Forex trading that are important to understand, and one of these concepts is equity in Forex trading. First of all, it has to be looked at in terms of when trades are open, and also in terms of when there are no active positions in the market.

Equity in Forex trading is simply the total value of a Forex trader’s account. When a Forex trader has those active positions in the market (during open trades), the equity on the FX account is the sum of the margin put up for the trade from the FX account, in addition to any unused account balance. When there are no active trade positions, the equity is known as ‘free margin’, and is the same as the account balance.Equity in Forex

 

What Does Equity in Forex Refer To?

What is equity in Forex? FX equity refers to the absolute value of a Forex trader’s account. When a trader has open positions, their trading platform will factor a number of parameters into the equity equation. For example, in MetaTrader 4 (MT4), the charts will list a number of figures in the terminal window:

The first parameter to understand equity in Forex is margin. It is the degree of collateral that the Forex trader must put up for the trade, in an attempt to utilize the leverage provided by the broker. You should keep in mind that the foreign exchange market is a highly leveraged market, enabling traders to put up a specific sum of money (the margin in our case) to control larger trades.

The next one in the list is balance. This refers to the total starting balance in the trader’s account on the whole. We should outline that it is not influenced by any open positions until all of your active trade positions are closed. The third parameter is unreleased profit or loss. What this refers to is either profit or loss in financial terms, that a trader’s account steadily accrues from in all open positions. As a matter of fact, they are referred to as unreleased, not true profits or losses.

Moreover, their presence solely indicates the actual state of the positions in the market, and as they are not yet added to the account, they remain unreleased, and are subject to change. They only become released profits or losses when the positions are closed, and this is the only time that they can be either added or removed from the trader’s account.

At this stage, no change can lead to a trader’s profit or loss. The last one in our list is trading equity in Forex. In turn, this refers to the true amount of money that one will be left with when all of the active positions are closed. In addition, the trader’s account balance is made up of the equity, and the unreleased profit or loss within an active position.

Generally, we may define the trader’s equity as the following: it is to a degree the profit or loss that the account sustains from either open or closed positions. Additionally, the equity changes as the unreleased profits or losses in active positions change accordingly. Furthermore, when the positions are closed, and the profits are added or losses are removed from the actual account balance, the FX trader’s equity is now known.

The concepts of account balance, leverage, Forex equity, and margin are actually intertwined. A Forex trader has to know how they all connect, so that they can maintain capital when trading. It is essential to note that traders who suffer the dreaded margin call are those traders who do not comprehend the interrelationship between leverage, equity, margin, and the account balance. In fact, they open positions in a way that does not create balance between the trading equity, margin requirements, leverage and the account capital.

Equity is also known as the crucial leverage factor. Mostly, equity on a Forex account should be higher than the margin utilized for trades. The leverage factor, or the equity applied for the trade, can go a long way in terms of defining the profits made, or the losses sustained on the account. This pushes us to the point of understanding why it is important for traders to understand how to use equity to generate a balance between the risk, and the reward of a trade, and the role leverage plays here. Knowing what Forex equity is important as well.

How to Calculate Equity If You Have No Trades Open

If you do not have any open positions, then your Equity is the same as your Balance.

EQUITY= ACCOUNT BALANCE

Example: Account Equity When You Have No Open Trades

You deposit $1,000 in your trading account.

Since you haven’t opened any trades yet, your Balance and Equity is the same.equity 1

How to Calculate Equity If You Have Trades Open

If you have open positions, your Equity is the sum of your account balance and your account’s floating P/L.

Equity = Account Balance + Floating Profits (or Losses)

Example: Account Equity When an Existing Trade  is Losing

You deposit $1,000 in your trading account.

Beyoncé tweets that she’s shorting GBP/USD. Because she’s Beyoncé, you follow what she says and go short also.

Price moves immediately against you and your trade shows a floating loss of $50.

Equity = Account Balance + Floating Profits (or Losses)

$950 = $1,000 + (-$50)

The Equity in your account is now $950.Equity in Forex 

Example: Account Equity When an Existing Trade is Winning

Beyoncé tweets again and says she’s changed her mind. She’s now long GBP/USD.

Not only is she Crazy in Love, but she seems crazy in trading also.

But because she’s the Queen B, you follow what she says and go long also.

Price moves immediately in your favor and your trade shows a floating gain of $100.

Equity = Account Balance + Floating Profits (or Losses)

$1,100 = $1,000 + $100

The Equity in your account is now $1,100.Equity in Forex

Your account equity continuously fluctuates with the current market prices as long as you have any open positions.

That’s why Equity is seen as a “floating account balance“. It will only become your “real account balance” if you were to close all your trades immediately.

What is the difference between Balance and Equity?

Let’s start with a simple answer.

If your account is “flat” or does NOT have any positions open, then your Balance and Equity are the SAME.

But if you do have open positions, this is when the Balance and Equity differ.

  • The Balance reflects your profit/loss from closed positions.
  • The Equity reflects the real-time calculation of your profit/loss. The Equity takes into account both open AND closed positions.

This means that when you’re looking at your Balance, it is NOT the actual real-time amount of your funds.

Since Equity includes current profits or losses from open trades, it is Equity that shows the real-time amount of your funds.

It’s possible to have a very large Balance, but very small Equity.

This happens when your open positions have a large unrealized (floating) losses.

For example, if your Balance is $1,000, and you have an open trade that has a floating loss of $900.

Your Equity is only $100.Equity in Forex 

 

Extra Tips Concerning Equity

If the market goes through a turn around and there is a decrease in the amount of losses, then more margin is actually freed up, and the equity will soon again surpass the margin. Moreover, the size of the new trade will then be defined by the extent to which the Forex equity exceeds the margin. There is also another potential situation: If the market continues to move against you, the equity will drop to a level where it will be less than the margin, making it nearly impossible to support the open trades.

Needless to say, the losing positions must be closed to balance out the equation, and protect the broker’s leverage capital.

Moreover, your broker can establish the percentage limit that forms the threshold value for this event to happen. If a broker sets the margin level to 10%, it implies that when the margin level approaches 10% rate (that is when the equity is 10% of the margin), the broker will automatically close out losing positions, beginning from the one with the largest floating loss.

If you are considering trading with Admiral Markets, keep in mind that we offer different account types for traders, depending on their client status. There are two types of traders: Retail traders, and professional traders. You find all the details relating to their differences on our account types web page.

If after the closing of a particular position with the largest floating loss, the market keeps on moving against the trader, so that the broker’s capital is once again threatened, the broker will take the same course of action to close out any position with the largest unrealised losses. It goes without saying that if the trader deposits more capital to enlarge the balance with an immediate deposit means of transaction (like a credit card), money can actually be taken from the new account balance to add to the margin, therefore keeping the positions open.

Having a good comprehension of the role of equity in Forex can undoubtedly help you as a trader in terms of maintaining structure within your trading activity, as well as avoiding taking on too much risk, that can potentially be doubled with the trader’s nightmare – the margin call.

Conclusion

Equity is one of the most important aspects of Forex trading. It is imperative to know that equity must be kept at levels that are high enough so that at no point in time will the account suffer when some losing trades are incurred. This can be by either increasing account equity, or by using proper leverage/margin requirements relevant to the account size. Try to test your newly-gained knowledge on a risk-free demo account. It is a safe way to see how well you’ve learned all of the information, and how good you are at applying it in practical situations.

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This Post Has 2 Comments

  1. Jc Hambly

    Very efficiently written article. It will be beneficial to anyone who employess it, including yours truly :). Keep up the good work – looking forward to more posts.

    1. PriceAction Forex

      Thank you for reading. We really appreciate your sharing the word about us.

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