We continue discussing the basics of Forex. This article will deal with the definitions of balance and equity and explain the difference between these two concepts.
Well, the definition of the account balance is simpler, so let us start with it.
The trading account balance is the amount of trader’s money at the moment without considering opened positions.
The balance reflects the profit/loss only from closed positions. The open positions and margin (collateral) are not included in the balance.
Now, let me explain the concept of equity. If we try to look up the word in the dictionary, the closest in meaning synonym will be capital. The capital means not only the current balance but also the profit (or loss) from the financial assets you have invested in.
Equity includes the total result of the trading operations and balance at the current moment. I will present the same ideas in the formula below:
Equity = balance + current result of the opened positions + swap – broker’s commission.
Equity could be lower than the balance in the following cases:
Existing trades are currently losing.
The profit from trades does not compensate for the swap or the broker’s commission.
Equity will be higher than the balance if the profit for existing trades is greater than the swap and broker’s commission.
Again, the primary difference between the balance and the equity is that the balance doesn’t include opened positions while the equity includes all current changes. So, the equity is a floating value; it could change at each specific time.
Important: equity doesn’t include margin
In MetaTrader 4, the balance is displayed in the Trade and Exposure tabs.
Why should the trader monitor equity?
Equity reflects the current situation on all opened positions of a trader. If you subtract the margin from the equity, you will calculate free margin, which could be used to enter new trades. If there is not enough free margin to hold the positions open, the broker will first send you a notification that you must top up your balance. If you ignore this notification and the market goes against you, the broker will close all your positions forcibly.
The notification about the need to top up your account to avoid closing positions is called Margin Call.
Forcible closing the position by the broker because of the shortage of free assets is called Stop out.
Brokers have different limits for Margin call and Stop out. The Stop Out level is usually about 20%-30%. You can see the Margin Call and Stop Out levels in the specification of the Forex account. For example, the LiteForex broker has the following values for the ECN and Classic accounts:
You can calculate the Margin Level according to the following formula:
Margin Level =(equity/margin)*100%
Monitor your equity and free margin level not to lose your deposit. If you have a working trading system, follow money management, and are careful with the risk per trade, your account will never reach the stop-out level.
I wish you successful trading!
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