In Forex trading, many key concepts are very important to understand.
Without proper knowledge of these concepts, you cannot go too long path. So one of the important concepts is ‘Equity in Forex trading’.
To understand this we have to look at when a trade is open and also look at when the market is inactive.
Shortly speaking in Forex trading equity means the total amount of money in my account.
When Forex trader actively joins the market I mean during the open trade, the total amount of equity is equal to the total amount of investment in the Forex Business.
If you are not trading actively, then the equity is known as free margin or you can call it the account balance.
Equity in Forex Refer To?
Forex Trade equity refers to the absolute value of a Forex trader’s account.
When a trader is an open position, the trading platform, for example, is Meta Trade will show few parameters into the equity option.
1st When we look at the Forex, the first parameters to understand inequity is margin.
It is the amount of collateral as security to trade if he wants to utilize the leverage provided by the broker.
You should be very careful because the Forex exchange market is very highly leveraged.
It allows traders to put a small amount of money and increase it so that they can trade a large amount of lot.
The second most important thing is the balance list. It reflects the total shared balance on the trader’s account as a whole. We should let you know that it is not affected by any open positions until all your trade options are closed. Unrealized profit or loss is the third parameter.
It refers to loss or profit in financial terms. Traders account amass all amount when it is open to the market.
Investor’s presence in the market truly describes the positions in the market but as the amount is not added to the account they remain unrealized but they can change. But they can only be realized whether it is profit or loss when it is closed.
It is the only time when you can add or remove from the account.
There are many ways to define a trader’s equity as follows:
- The Amount the profit or loss that the account from either open or closed positions of the trade.
- The number of Equity changes from the unrealized profits or losses in active positions.
- When you close the trade, if it is profit, it is added or if it is losses, it is removed from the actual account balance then you will know the total amount of Forex equity.
The idea of account leverage, balance, equity, the margin is interconnected.
As a Forex and Stock trader, you have to know all these things so that you can manage your capital while trading.
There are many traders who fear the margin call because they do not understand the interrelation among the leverage, account balance, equity, margin.
Equity is also known to be a very important subject in Forex trading.
If you look, you will find most of the cases Forex equity is higher then there margin used to trade. The terminology leverage and equity are frequently used in the Forex trading business. It also can be used to define the profit and loss of a particular account.
That makes it very important to maintain the risk-reward ratio.
The Lot size leverage and margin all work together when it comes down to the mathematical formulas.
How many Pips you will earn is determined by your lot size.
You cannot trade $1 or $2, rather you have to do it in a lot size. so each small block of currency is called lot size.
There are three basic ideas of lot size:
- Micro lot: 1000 Dollar
- Mini lot: 10,000 Dollar
- Standard Lot: 1,00,000 Dollar
So if you look at the EURO/USD , what would be the lot size?
- Micro lot: $0.10 per PIPS
- Mini Lot: $ 1.00 Per PIPS
- Standard Lot: 1,00,000 Dollar
Margin is a requirement of deposit which is used to open and maintain the open position.
But you have to remember this is not a transaction cost. It is a path of your account balance which is set aside which is allocated as a deposit to starch the trading.
According to the rule, margins are multiplied by leverage to determine the lot size. Margin it shows the real money from your trading account.
Now example you want to trade 1 micro lot which is worth $1000. And if your broker now offers you 1:50 leverage.
So now if you want to maintain this $1,000 micro lot then you have to keep $20 of margin in your account.
So if we put this in the equation will find:
$20 (Margin) x $50 (Leverage) = $ 1000.
Taking the money your broker will separate it during the trade but you will get back it, doesn’t matter if you win or lose in the trade.
and Free Margin = Equity – Margin.
Leverage is another very important aspect of Forex trading.
As the market moves in a very slow direction we have to enlarge the lot size to make real money.
The broker offers a different range of leverage it starts from 1: 10 and up to 1:500.
Lot Size = Margin x Leverage.
If the market starts to recover and if the amount of loss starts to decrease then the margin becomes free and at some point, equity exceeds the margin.
After that, the size of the new trade will be the new equity which was increased previously, but it can vice versa.
If the market moves against you the equity will decrease to the level where it will be lower than the margin. Which might make it impossible to support the open trade.
At the same time, it is very necessary to mention that any losing position must be crossed so that we can balance our equity and protect the leveraged capital.
On the other hand, a broker can set a percentage of the margin and if it remains constantly towards the downtrend at some point the account will be closed automatically.
So if the trader still wants to maintain the account open, he has to bring more capital on that account, his balance will decrease but the account will remain open.
The broker house offers a different type of accounts for the traders depending on the nature of the clients. There are two kinds of traders:
- The retail traders
- The professional traders
So having good comprehensive knowledge about equity can help you to manage your capital and to comprehend the imminent risk and reward ratio.
So we should keep our equity high enough so that it doesn’t get exposed to the danger zone.
Show the best way is to apply your newly grown knowledge in the demo account and after that, you can trade in real account.