Understanding What Equity Is in the Forex Market
Welcome to this lesson! Today, we’ll be diving into an important concept every forex trader must grasp.
Equity is a critical metric that holds significant weight in your trading journey. Understanding your trading account’s equity empowers you to make smarter decisions and helps you determine the appropriate position size to open in the financial markets.
Let’s break it down.
What Is Equity in Forex?
In simple terms, equity represents the current value of your trading account. It includes your account balance plus (or minus) any floating profits or losses from open trades.
Your equity will fluctuate in real time as the market moves, rising with floating profits and decreasing with floating losses. However, when you have no open positions, your equity equals your account balance.
This relationship can be expressed as:
Equity = Account balance
Example:
If you just opened a forex trading account and deposited $3,000, your equity is also $3,000. But once you place a trade, your equity starts adjusting according to the trade’s performance.
How to Calculate Equity When You Have an Open Trade
Although most brokers calculate this for you automatically, it’s essential to understand the formula behind it:
Equity = Account Balance + Unrealized P/L (Profit or Loss)
Or simply:
Equity = Account Balance + Floating Profit/Loss
If Your Trade Is in Profit
Let’s assume:
- Your account balance = $3,000
- Your open trade is in profit with $100
Then:
Equity = $3,000 + $100 = $3,100
Your account equity has increased due to the floating profit.
If Your Trade Is in Loss
Let’s say:
- Your account balance = $3,000
- Your trade is currently showing $100 in floating losses
Then:
Equity = $3,000 + (-$100) = $2,900
As a result, your account equity decreases due to the floating loss.
What Is Floating or Unrealized Account Balance?
When you have open trades, the unrealized profits or losses (also called floating P/L) cause your account balance to fluctuate constantly. This is referred to as the floating account balance.
Only when trades are closed, whether in profit or loss, does this floating balance become realized and reflected in your actual account balance.
The Difference Between Account Balance and Equity
- If you have no open trades, your equity = balance.
- If you have open trades, equity will differ from the balance due to floating P/L.
Here’s the breakdown:
- Account Balance: Shows profits/losses from closed trades only.
- Equity: Reflects the real-time value of your account, considering both open and closed trades.
It’s possible to have a large balance but a very small equity, especially if your open trades are deep in loss.
Example:
If your account balance is $3,000, but your current trade is floating – $1,500, your equity would be:
Equity = $3,000 – $1,500 = $1,500
Final Thoughts
By now, you should clearly understand what equity means in forex trading. While most brokers simplify things by calculating it for you automatically, it’s still vital to learn how to do the math yourself, especially if you want to become a professional trader.
In our next lesson, we’ll dive into Free Margin, another powerful metric you must understand. Don’t miss it!
