What is Equity in Forex Trading?

What is Equity Forex?

Equity in business finance refers to the amount of money that goes to the owner or shareholder of an entity after paying off all debts.

Therefore, forex equity is the amount of money that a Forex trader remains with if all open trades are closed. It is the total value of the trader’s forex account, which includes the sum of the margin used for open trades plus unused account balance.

When a Forex trader deposits money on their Forex account, the amount that will reflect without trading is the account balance. At this point, the trader’s equity is equal to the account balance.

Once the trader opens a new position, the equity will be the opening balance plus any profit and bonuses, minus all losses.

Equity = account balance + bonuses + profit – losses.

Here is an example of a forex equity:

Suppose you decide to open a live trading account with FXPesa using $200.

Equity = Opening Capital = $200.

Suppose then that you start trading and buy EURUSD, then the market goes according to your expectation and you make $5.

Equity = $200 + $5 = $205.

However, the account balance will remain $200 until you close the trade. So, if you close the trade and don’t open another one, the new account will have:

Equity = Account balance = $205.

Assume that you become too excited and buy GBPUSD while the other position is open, so you have two open positions. However, this new trade gives you a loss of $15. Your new forex equity will be:

Equity = 200 + 5 – 15 = $190.

If you stop loss in the GBPUSD order and take profit in the EURUSD order, you will have a new account balance of $190.

Equity will keep adjusting as long as your forex positions are open, depending on how the market moves.

Therefore, the forex balance is not affected by movements in the market until you close all open positions. Equity fluctuates as unrealized profits and losses of the open positions adjust on the forex trading account.

Before you close any open position in your trading account, you will see unrealized profit or loss. They only become actual profits or losses when you stop open orders, and in that case your account balance will change when you close the order.

Why is it important to understand equity in forex trading?

Forex trade should be knowledgeable about the concept of forex equity because it enables the trader to find the right balance between risks and rewards in their live trading account.

Equity is very important in your risk management because it enables you understand when you should open a new order, stop loss, or take profit.

The equity applied on your forex account determines your leverage factor and your profits. If your equity falls too low as a result of losses, you can either add more funds in your account to increase the account balance and equity, or close orders that are making losses.

When you close your open positions, the losses or profits you realize will be added to your account balance, and that affects the amount you can withdraw or open new trades – your actual amount.

If the equity falls below your margin (the amount you use to trade), then you will not be able to execute new trades. The equity may also go further down to a point where you can get a margin call or a stop out, in which all your losing trades are closed. Thus, you should always be careful to keep your equity above your margin.

In case your open trade is at a loss and there is no sign of reversing, yet there is another currency pair that has a better potential, you should stop that order to free some equity and start trading on the new position with better potential.

You may also close the losing positions when you want to balance out your account and protect the leverage capital from potential erosion. Look at this live example of Forex equity on meta trader 4:

Forex equity and margin

In the example, the trader’s account balance is $487.50 and the equity is $473.38. This means that the current open positions are trading at an unrealized total loss of -$14.12 ($487.50 – $473.38). The used margin is 157.15, and the free margin or available margin is 316.23. This means that the trader still has a big margin that is capable of opening a new position with a lot size of 0.03 (or $300).

Therefore, you should always ensure that your free margin is high, and the used margin is smaller than the equity.

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