Equity is one of the key terms in Forex trading. Equity in Forex is the amount of money one has on their account. However, it is not as simple as that because the concept of equity is dependent on the open positions in the market. If an investor has an open account position the final number of equity will change due to its unrealized losses or the profits. When the market positions are closed, the result will be added to the traders’ accounts and will represent the final amount of equity.
There are a lot of factors that have a big effect on equity, for example, leverage, margin, balance, account type and size, and unrealized profits and losses. All these terms are very important to consider when talking about the meaning of equity. They all are connected with each other and this is why every trader is recommended to know each of them in order to have successful trading.
It should be noted that there are three main types of equities including available equity, negative equity, and positive equity. In many cases, people think that the concept of equity and balance in Forex is the same thing. However, this is not true because balance is not the real amount of money that is on the account, it is just the number that was displayed before opening positions in the market. After an investor closes the position, the final resulted will be added to the equity number, this is the unrealized loss or profit, according to the success of each trade. This is why it is very essential to always consider this difference. Some might think this is a small factor, however, this mistake may not end up very well in the future.
We will further discuss some other important features related to the concept of equity. Besides, we will analyze the main vital factors that have a big impact on this term and try to represent the meaning of equity in a clear and obvious way.
The Main Factors That Affect Equity
There are several factors that have a huge impact on the concept of equity. So let’s have a close look at each of them and analyze the major facts in a detailed way.
Account Balance
As we have already mentioned, the account balance and FX equity are often misinterpreted as the same things. These two concepts mean the same thing only when an investor hasn’t any open positions in the market. However, one should always remember that when the traders open or hold a position, the account balance stays the same but the number of equity changes according to the unrealized profits or losses that will be added to the balance after the position will be closed. This means that if the market performance goes well and the trader’s position will go in a good direction, they will be able to generate an unrealized profit after. However, if one failed in their position, they will experience the unrealized loss that will be affected negatively on the final amount of equity. After closing the positions, successful or not, the account balance and the equity will still become to be the same thing.
Unrealized Profit and Loss
As we have already discussed, unrealized profits and losses will be realized when the traders’ position in the market will be closed. The account balance will change due to the results it will end up with. Professional traders do not recommend traders to wait for their losing positions until it becomes profitable and close their profitable trades very early. On the contrary, the most profitable investors try not to wait for their losing positions to change, however, they cut the losses and generate profits that will be displayed in the final number of FX trading equity.
Margin and Leverage
Margin and leverage also have a big influence on the concept of equity. There is the very active use of leverage in the Forex market which means depositing small money in order to generate a big amount of profit. However, when trading with leverage, an investor has to pay for it like an interest rate, this amount of money one is charged because of using leverage is called margin. The number of equity is closely related to the margin concept. There is a formula that says that Equity = Margin + Free Margin and Equity = Balance + Unrealized Profits/Losses.
However, people should also remember that there is always a chance to occur margin calls while trading. A margin call is a situation when the trading process with the leverage tool will not go well so your trading account will immediately be closed by the Forex broker.
FX equity but sometimes people find it very hard to understand the main idea behind it. This is why the meaning of equity becomes a little harder to comprehend. However, the main thing that should be remembered about these terms is that free margin is the equity including all trades an investor has opened in the market at the given moment.
On top of that, another noticeable concept is the margin held that represents the total number of funds an investor has opened as a trade at a given period of time. This is all that should be taken into account in terms of margin and leverage. For some people, it might seem a little complex, however, if they take close attention to each of them, they will definitely understand the main idea.
Other Considerations About Equity
It is important to mention that there are three major types of equity including balance equity, floating equity, and negative equity. Account equity is the same as the above-mentioned account balance which is the number of capital an investor has on their account without any opened position. Floating FX trading equity is all the capital a trader has that is not on their balance yet.
Negative equity is the situation when the market performance goes in the undesired direction and a trader can not manage to gain profits. In that case, there will be no money remained in the account. The best way to stay away from the negative equities is using stop-losses.
The Bottom Line
As we have already mentioned above, equity is one of the most important concepts that traders will come across in the Forex market. Equity is the total amount of money in the investor’s account. However, this meaning goes far if we consider some details. There are a lot of people who do not understand what is equity in Forex and how does it apply to trading because sometimes it is a little hard to understand the actual meaning. However, we have discussed that there are several factors that have a huge impact on this concept including account balance, unrealized profit and loss, margin, and leverage. Each one has its own important details that need to be considered by the investor before opening the trading positions in the Forex market.
Besides, another noticeable thing is that traders should not use account balance instead of equity because it is a big mistake and sometimes it might end up with unpleasant circumstances in the trading process. So every trader, especially the beginners should take close attention to this concept before they decide to start trading in Forex.