What is equity in Forex trading?
Equity in forex trading refers to the amount of money a trader has in a trading account, plus or minus the profits or losses on running trades. If there are no open trades, the account equity would be the same as the balance. Therefore, the equity is the current account balance (if there are no open trades) or the future account balance (if there are open trades).
How exactly does equity work in Forex?
Equity is the sum of the account balance and the open trades. The status of the running trades also influences the equity because trades that are moving favorably usually free up more equity. This means that when your open trades make more profits, your equity increases also. Losing trades tend to reduce your account equity.
As long as you have open positions, your equity will fluctuate due to the volatility of the forex market. As a trader, you should avoid having negative equity. Negative equity occurs when your trade turns out to be non-profitable, consequently wiping your account.
How do you calculate equity in Forex?
Calculating equity in forex is quite simple, mainly because most trading platforms now show you your balance and running profits or losses. If you have an open trade, you can calculate your equity by subtracting your loss from your balance or by adding your profits to your balance.
Imagine that you have a GBP/JPY short trade open. The trading terminal is telling you that you are currently 1000 dollars in profit. This would immediately affect equity. The balance, however, would show precisely the exact amount you had when you opened the trade. The account equity will be showing an adjusted amount. This amount would be greater than the equity if you are making profits and vice versa.
Assuming you had $2000 when you started the trade, the account balance would still be $2000, but your account equity would be $3000.
3 Reasons Why Equity is Important in Forex Trading
It affects the number of trades you can open
Your equity affects the number of trades you can open as well as the contract sizes. The lot size you can open per trade increases as the equity increases. If you have limited capital, opening a trade that turns out profitable releases equity for you to use to open new trades. The lower the equity, the lower the contract sizes you can open. For instance, if you have many losing trades open on your account, then the contract size for subsequent trades would be limited.
It helps you grow as a trader
If you’re serious about becoming a mature and successful trader, trading a significant equity amount might help you grow and develop. Learning to trade with more significant equity is a great way to stretch your limits and improve your trading skills.
It influences how much profits you generate
Your equity controls how much profits you can generate on your account.
If the risk percentage is kept constant, then higher equity would generate more profit than smaller equity.
What is the difference between balance and equity in Forex?
If you have no open trades, then your equity is the same as your balance. If you have open trades, then you need to factor in your profits or losses to give you your equity.
If the open trade is profitable, then the balance plus floating profits is the equity. If the open trade is a losing trade, the balance minus floating losses is the equity.
Tips to Remember When Dealing With Equity in Forex Trading
Monitor your trades to avoid a margin call
While trading, make sure you monitor your risk and position sizing to ensure that your equity and margin can cover the potential losses you may incur. If not, you would receive a margin call. This happens when your account’s margin no longer meets the margin requirements. In other words, the account needs more funding.
Match your equity to your leverage
In forex, leverage increases the purchasing power of your deposited funds. Matching your equity to your leverage makes sure that you can trade enough position sizes to help you make profits. But, make sure you use proper risk management because too much leverage can increase the risk exposure on your account.
Take partial profit
While trading, you should learn to pay yourself by taking partial profits as your trades move in your favor. This ensures that a portion of your floating profits is now secured as a part of your account balance. Taking partial profits is a great trade management strategy to adopt to improve your equity, balance, and account growth.
Learn more about equity in Forex trading with Decode Global
Now that you have understood how forex equity works, you can learn more by signing up on a forex brokerage platform, then executing and managing your trades. Make sure you use proper risk management by predetermining your risk percentage before each trade.