Most retail forex traders are already familiar with what the balance in their margin trading account refers to since it is analogous to the balance in their bank account. They may not know what the terms “account equity” or “equity” in forex trading refer to when used in an accounting context.
To forex traders, the accounting term equity does not refer to stock as one might think but instead to the amount of cash they hold in their margin trading account plus any unrealized gains or losses associated with open positions that they are currently holding. Unrealized gains or losses are sometimes also called floating gains or losses.
Account equity shows the temporary current value of a trading account given present market exchange rates. Also, phrases like forex equity and trade equity refer to the amount of cash you would have left in your brokerage account if you closed out all forex positions at current market levels.
Read on if you are curious about what is equity in forex trading and want to know how to calculate the trading equity in your forex account.
Understanding Equity in Forex
The account or trade equity you have in your forex trading account refers to the total current value of your margin account. This equity measure is equivalent to your account’s balance plus or minus gains or losses from open positions you are running.
Your forex trading account’s equity is roughly equal to the amount of cash you would have left over if you liquidated all open trading positions at current market exchange rates. If you have no open trading positions, then your account equity is equal to your account balance.
The equity value of an account is higher than its balance when its open positions are showing an unrealized profit. Conversely, the equity value of an account is lower than the balance when its open positions show an unrealized loss.
Unrealized gains and losses reflect changes in valuation attributed to open forex trading positions. They are computed by comparing the trade entry exchange rate to the present market exchange rate.
Unrealized gains and losses result from positions that have changed in value but have not yet been closed out. Unrealized gains and losses become realized once the position is actually closed. Resulting profits or losses are then considered realized and are reflected in the trading account’s balance.
How Forex Equity is Calculated
Calculating your FX trading equity is relatively simple if you already have a system that shows you what your unrealized gains and losses are. You can use the following equation to calculate the forex equity in your trading account:
Equity = Balance + Unrealized gains or losses
When you have no trades open in your trading account, then your account’s trading equity is identical to its balance.
When you have unrealized gains in your trading account, then the equity equals your cash balance plus those unrealized gains. When you have unrealized losses, then your equity equals your cash balance minus those losses.
How to Use Equity in Forex
The account equity measure marks the value of your trading positions to the foreign exchange market in real-time and then adds that amount to your cash balance. Forex traders can look at their current account equity to determine if they should prudently take on additional risk, sit tight or close out some positions to reduce their risk.
Online forex traders should also monitor their margin account’s equity to make sure it does not approach the point where their broker will automatically close out their positions.
Some traders might use their account equity to determine when they should exit their trading positions. For example, they might wait for a trade to reach an equity level of $100 to close out a winning position they have entered. However, this is not an ideal way to trade since your market analysis should really take precedence over just looking at your account or position equity numbers.
If you would like to monitor your account equity in practice, you can usually have your account equity computed in real-time by decent online trading platforms that usually display it in the lower left corner of the trading screen.
For example, MetaTrader 4 shows your account equity in color next to your balance, while MetaTrader 5 shows the equity on its Trade tab next to your trading account balance.
Forex Equity Example
As a practical example of how forex equity is calculated, consider the situation where a forex trader has made a cash deposit of $2,000 into their margin forex account held with an online forex broker.
The trader then opens up two positions at present market rates. After 10 minutes, one of their open trades is showing an unrealized loss of $100, while the other trade is showing an unrealized gain of $200.
In the above example, the trader’s account balance is still $2,000 since they have not realized any of their trading gains or losses yet, but their account equity is calculated as follows:
Equity = $2,000 + ($200 in gains - $100 in losses) = $2,100
Note that the trader’s net unrealized trading gain of $100 is added to their account balance of $2,000 to get their resulting trading equity of $2,100.
What Is the Difference Between Balance and Equity in the Forex Market?
The balance in a forex brokerage account consists of the fully-realized cash amount that is currently credited to the account. In contrast, the equity of the account is equal to the balance plus any unrealized gains or losses.
If an open trading position is underwater, then it has an unrealized loss associated with it that diminishes your trading equity. An unrealized loss is not deducted from your account’s balance until you actually trade out of the position.
Alternatively, if an open trading position is winning, then it has an unrealized gain or profit associated with it that boosts your trading equity. An unrealized gain does not increase your account balance until you actually trade out of a position profitably.
Should You Use Equity to Trade Forex?
You should definitely keep an eye on your overall account equity to make sure that your trading account is not heading into negative territory as a result of losing trades. This situation can result in an untimely and usually very unprofitable closeout of all your trading positions if your online broker implements such a safeguard.
With that noted, using the absolute equity level associated with a position as a signal to exit that particular trade is less optimal than using market analysis and your preferred trading strategy to make trading decisions.
It is generally best to focus instead on what chart points, chart patterns, technical indicators and other fundamental and technical factors suggest when deciding on the best time to exit a trade.
It is also important for forex traders to understand the relationship between account balance, equity, margin, and leverage. These concepts are all intertwined and traders who suffer a margin call typically do not understand the interrelationship of these concepts. Traders should avoid opening positions in a way that doesn't create a balance between trading equity, margin requirements, leverage, and account capital.
If you want to practice using equity in forex before you start trading with real currency. Try using a demo account to get a better feel for forex equity trading.
Frequently Asked Questions
What if equity is negative in forex?
If your forex trading account’s equity is negative, then you will have lost all of your margin deposit and then some if you close out all of your positions at the current market levels. Also, many online brokers will automatically close out all positions in a forex trading account with negative equity or when an account’s equity approaches zero by some distance that they generally specify in their terms and conditions.
What happens when equity is zero in forex?
This situation means you either have a zero account balance and no open positions or your open positions are showing an unrealized net loss precisely equal to your account balance. Also, if you have open positions and zero equity, then many online brokers will automatically close out each of your trading positions.
Why is equity important in forex?
Your account equity is important to watch to ensure that your trading account is not heading into negative territory because of losing trades which can cause your broker to automatically close out all your trading positions.