Whether you’re a seasoned forex trader or just getting started, you’ve probably heard the term “equity” thrown around the trading world.
But what does it really mean, and what impact does it have?
In this post, we’ll explain the concept of equity in forex trading and what impact it can have on your trading strategy. We’ll also look at the ways you can use it to your advantage and how to track it to ensure your trades are profitable.
So, if you’re looking to take your forex trading to the next level, this post will help you get there!
Equity explained
When it comes to equity in forex trading, it refers to the total value of the foreign exchange or foreign currencies in your trading account. Many newbie traders confuse equity with Balance or margin, but they are not the same thing. Equity is the total amount of currency you have regardless of your profit or loss positions in an open trade. If there is no open trade in your account, equity and Balance become one and the same. However, if there is open trade, equity stands on its own.
Depending on the trading platform you use, your equity value will be displayed for you to see when you log into your trading account. For example, if you use a Meta Trader 4 platform, your equity will be placed in the Terminal window just under the trading tab. However, if yours is an MT5 trading platform, equity will be placed in the Toolbox.
The reason why Equity is such a confusing subject is because when there are open trades and you are watching the charts in real-time, equity does not change until the end of the trading cycle. So, if the cycle ends in profit, equity increases; if it ends in a loss, equity decreases. So, for better understanding, just consider equity to be the full amount of money a trader deposits into his account regardless of whether he has made a profit or a loss during a trading cycle.
Equity formula and calculation
The formula for calculating equity is quite simple and represented as
Equity= Trading Account Balance + Floating Loss or Profit
To give you a graphic understanding of how this works, let us consider the following examples.
Suppose you have $500 in your trading account and you do not have any open trades; your Equity is $500
Now, if you still have $500 in your trading account and you have a 10 pips trading window open, and it is in profit, your Equity = Account Balance plus the floating profit= $500 + $10 = $510
In another example, let us assume that you have an open trade with 10 pips, and the trade is in a loss position; this will translate to Equity = Account Balance plus floating loss = $510 – $10 = $490.
The reason why it is called a floating loss or profit is because the trading window is still open. If you are knowledgeable about forex trading, you will know that a trade is never called a profit or a loss until the trading window closes. For example, a 5 minutes window can run on profit for 4 minutes 59 seconds and end as a loss at the last second, and vice versa. This is why Equity never changes until the window is closed.
How is Equity different from Balance?
Since we now know that Equity is the total amount you have in your trading account minus profit or loss in an open window, how is balance different from equity? At a base level, Balance is how much you have left in your account after a trading window closes. The figure is not subject to profits or losses but what is left. Sounds like equity, right?
Yes, but not all the time, depending on the circumstance. For example, if you had $500 in your trading account and a trading window ended in a loss of $1, your Balance will become $499. How then are they different?
In the case of equity, it is the same as your Balance for all open trades. So if you have two open trades with different timeframes and the first one closes, your Balance and equity will be the same even as the second window is still open. What this goes to show is that equity is constantly changing as long as there is an open window.
In the case of trading balance, the figure is static and will never change unless a trading window closes and there are no open windows left. While equity floats in line with profits and loss, Balance remains the same until there are no open trades left. However, they become the same once all windows are closed.
How to protect your equity and minimize risk when trading forex?
Forex trading is a highly risky endeavor, and the best traders only become so after years of practice and errors. As a newbie, you will have to learn the ropes through your personal experiences and the experiences of others, but there are ways you can protect yourself from sustaining significant financial losses. Here are some ways.
Trade with money you can afford to lose
This may sound stupid as no one wants to willfully lose even $1. However, consider your first set of investments into forex as a gift to yourself, but one that will not give you any value. If you trade with money you can afford to lose, you will not fall into financial ruin even if you lose all your equity. What you consider game money may be worth more or less to someone else; however, risking what you can afford is one way to protect yourself.
Use limit orders are stop loss
Traders who don’t use stop losses run the risk of losing all their money. To minimize potential losses should the market turn against you, always use stop losses to mitigate such risks. As for limit orders, giving this instruction to your forex broker will prevent you from buying undesirable assets.
To better manage your risks and safeguard your equity, there are several risk management techniques we implore you to read about to become a better risk manager.