What is Equity?

What is Equity? Lesson No 33

Okay, let’s understand about “equity.”

Equity simply means the current worth of your trading account. Consider it the current balance in your account.

As you observe your trading platform on your screen, you’ll see that this figure changes with each market movement. This occurs because your Equity contains not only the money you initially invested (your account balance), but also any profits or losses from open positions that have yet to be realised.

So, when the value of your present trades rises or falls, so does your equity. It’s like watching your account’s value fluctuate in real time.

How to Calculate Equity When You Have No Trades Open

If you have no open trades, your equity is equal to your balance. In other words, your Equity is the amount of money in your trading account when there are no current trades affecting it.

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Example: Account Equity with No Open Trades

You begin with $1,000 in your trading account. If you haven’t traded yet, your Balance and Equity will remain at $1,000 because there have been no gains or losses that alter the value of your account.

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How to Calculate Equity When You Have Trades Open

If you have any open trades, your equity is computed by adding your account balance (the amount you initially deposited) to the floating Profit/Loss (P/L) of your open positions. This combined value represents the total value of your trading account at the time, which includes both your deposited cash and any unrealized gains or losses from current trades.

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Example: Account Equity When a Current Trade Loses

You begin with $1,000 in your trading account. Inspired by Beyoncé’s tweet about shorting GBP/USD, you decide to take a short position.

However, as soon as you enter the trade, the price goes in the opposite way, resulting in a floating loss of $50. This indicates that if you close the deal now, you will lose $50 in addition to your initial investment.

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Your account’s equity is now $950.

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Example: Account Equity When an Existing Trade Wins.

Following her initial tweet about shorting GBP/USD, Beyoncé tweets again, this time having a change of heart and stating that she is now long GBP/USD.

Despite the sudden shift in her trading strategy, you decide to follow Beyoncé’s example once more and go long on GBP/USD.

Miraculously, as soon as you enter the deal, the price begins to move in your favour. Your transaction has a floating gain of $100, which means that if you closed it right now, you would profit by $100 on top of your initial investment.

It’s an exciting ride, but even the most unexpected turns can result in profits in the trading world!

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The floating gain of $100 from your trade following Beyoncé’s revised tweet has increased the Equity in your account to $1,100. This indicates the current worth of your trading account, which includes your initial investment as well as any unrealized gains from open positions.

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Consider your account equity to be a thermometer that changes with the market. It updates whenever you have a trade open.

Equity is an image of your account’s current value. It is not permanent, much like a painting on a whiteboard.

We refer to it as a ‘floating account balance’ because it is not fixed. It only becomes your ‘real account balance’ when you have closed all of your trades.”

What is the difference between balance and equity?

When your account is flat (with no open positions):

If you do not have any trades active, your Balance and Equity are equal. Both indicate the quantity of money in your account.

When You Have Open Positions:

Your Balance shows the profit or loss from trades you’ve already closed.

Equity, on the other hand, represents the present evaluation of your profit or loss. It examines both open and closed trades.

Understanding The Difference:

Your balance may appear large, but your equity reflects the actual amount of money you have right now because it includes profits or losses from open trades.

It is possible to have a large balance but just a little equity. This happens when your open trades have significant unrealized losses.

An Example:

Assume your balance is $1,000, but you have an open transaction with a floating loss of $900.

In this case, your Equity is just $100, which represents the actual amount of money you have after deducting the losses from your open trade.

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Summary

Okay, everyone, let’s review what we’ve covered at this point.

First, we talked about equity. Equity is the sum of your account balance plus any gains or losses from open trades. It displays the current value of your account, which is very essential to keep track of.

In our previous courses, we covered some essential points:

Margin Trading: Understand how your margin account works and why it’s so important to have.

Balance: This is the amount of money in your trading account that is currently available.

Unrealized and Realised P/L: This is where we discussed how profits and losses affect your account balance.

Margin: When you open a trade, you must reserve a specific amount of money called Required Margin.

Used Margin: This is just the entire amount of margin that is currently locked up to keep your transactions open.

Now let’s look at Free Margin. Stay tuned!