We all go into the market with whatever we have at our disposal. Some take more and some take less. The actual money that we bring with ourselves to the market is known as equity.
In the forex market, equity is the total value that exists inside of your trading account. Equity can also undergo any changes that might result from your trades or positions.
This means equity in forex is equal to the money you deposit into your trading account plus all the money that you potentially obtain or lose as a result of your positions.
The idea behind equity itself is straightforward. In this article we want to see how you can go about calculating your account equity when you have positions open and also closed.
Forex Equity with No Open Positions
There is actually a difference between your account balance and your account equity. As it stands, if you do not have any open positions, then your balance and your equity are the same.
This is because you haven’t yet done anything with the money you had already deposited into your account.
So, for instance if you have deposited $5,000 to your account with the broker, then your equity is equal to 5 grand. But because you don’t have any open positions, so is your account balance.
Forex Equity with Open Positions
But what happens if you decide to take that $5,000 and start trading with it?
Well in that situation depending on your open positions, your account equity and your account balance will no longer be the same as each other.
In this situation, your equity will be the balance of your account in addition to any potential (unrealized) profits or without any potential losses.
So let’s go to our previous example. You have $5,000 in your account as your balance:
Balance = $5,000
You enter into a position, whether long or short, but it doesn’t turn out the way you want it too. So you go into a little bit of loss. For example, let’s suppose you are at a loss in the amount of $200.
In this case, this loss is called unrealized loss or potential loss. Of course it is because this loss has not yet settled into your account. It is in fact part of an open position.
So in this case, your equity would be your balance without the potential loss. It will be as follows:
Account balance: $5,000
Potential (unrealized) loss: $200
Equity: $5,000 – $200 = $4,800
At the same time, if you position goes into profit, that would also change your equity in the following way:
Account balance: $5,000
Potential (unrealized) profit: $200
Equity: $5,000 + $200 = $5,200
And this is how the concepts of balance and equity are different from one another. So next time when you think that they are the same as each other, think again!
What Happens If You Lose Your Equity?
So what will happen if you keep losing on your open position one after the other? Naturally you will keep losing your equity.
It is rather obvious that without equity you literally would not be able to trade. You need to have equity in your account to be able to use that money to open positions.
But there is another significance to account equity.
In almost all markets, including the foreign exchange market, traders will use leverage to open larger accounts that can have a higher chance of profits.
To use leverage, as you may know, you need to dedicate margin to the broker which is deducted from your account equity.
So if you lose your account equity you will not be able to use leverage for trading. This means you do not even have to lose all of your equity to stop the broker from allowing you to use leverage.
Even if your account equity becomes lower than the required margin, then you will receive a margin call and eventually you will be stopped from trading.
Given the importance of equity, let’s see how you can increase and protect your equity in the forex market.
How Can You Increase Your Account Equity?
Perhaps it is rather obvious, but the first method of increasing your equity would be to increase the balance of your account. You can deposit more money into your account any time you want and in this way increase your equity.
But this is not a sustainable method. You cannot simply keep depositing money into your account. There must be better ways to keep the equity in your account and even increase it.
Ways to Protect Your Forex Account Equity
Have you ever heard the phrase the best defense is offense? Well, it is also true about the forex market. You cannot simply keep defending yourself against the market by depositing money into your account and in that way protect your equity. As we mentioned, that method lacks sustainability.
You need to go on the offensive!
First you need to protect your equity and then increase it. The best method to protect your account equity is to use proper risk management protocols and techniques.
First and foremost, if you are new to the market, you should start doing so with the help of a demo account. Many brokers offer demo trading to their clients. With the help of a demo account, you can learn how to trade without risking your real equity.
Then when you are ready to enter the market and start trading with a real account, you need to have a proper trading plan. A trading plan will always keep you disciplined and help you stick to a set of rules and guidelines.
This way, no matter what happens in the market and how things change, your sentiments and your emotions will not affect the outcome of a trade.
In addition, you need to use risk management techniques and tools that can help you further protect your assets. This includes stop loss orders to make sure you do not lose more than you can tolerate.
Additionally, if you want to trade with the help of leverage, make sure to pick a rate of leverage that is suitable to your situation. Sometimes using leverage with a high rate will lead to losses that are just beyond the threshold of your equity tolerance.
With proper risk management techniques and gaining enough knowledge, you can start gaining on your positions and in this way increase your equity.
Equity is the very first thing you need to start trading. It is the money! In fact, it is the total assets that you have available in your trading account. Naturally, you can see just how important equity is. For this reason, you need to do whatever in your power to protect and also increase your account equity to be able to continue trading.