The term equity probably won’t be too strange for forex investors because you’ll always see it whenever you trade on a trading platform like MT4. However, for new investors, the concept of Equity is still rather vague and it is impossible to distinguish it from the Account Balance. This article explains what equity is, how equity is calculated, and how it relates to other concepts.
What Is Equity on MT4?
On the MT4 software, Equity appears along with many other concepts in the Terminal window, the Trade tab, where investors will monitor the current account situation and open trading orders.
Capital is the current value of the trading account. When there is an open order, equity is the sum of the account balance plus the profit/loss of available orders. Therefore, equity will not be fixed but constantly evolving.
How to calculate net worth:
Equity = Balance + Profit/Loss of Open Positions
What is the difference between Equity and Balance?
The most significant difference between Balance and Capital is that the Balance will be fixed during the period in which trading orders are opened. Fairness is constantly evolving.
The balance is the amount of money available in the trading account. When you open a new account, the balance is the amount of money deposited into the account for the first time. The value of the Balance only changes until the investor closes all orders, then the Balance will be updated by adding/subtracting the profit/loss.
Example: Deposit $500 into your forex account. So, Balance = Equity = $500. Then open 1 Buy EUR/USD trade:
- If that trade is losing $10: Equity = $490; Balance = $500
- If that trade is making $5, Equity = $505; Balance = $500
- If you decide to close the order with a profit of $ 8, balance = $ 508.
Therefore, it can be understood:
When there is no active position, the profit/loss is zero. So, Equity = Balance.
When there is an active position, if your trades are profitable, the equity will be greater than the balance. Conversely, the equity will be less than the balance when the open position is at a loss.
It is easy for new traders to confuse these two concepts with each other, often with a typical mindset:
Look at the balance when the account is negative in the hope of compressing the loss until the capital is equal to the balance and then close the order.
Or look at Equity when the account is profitable and expect the account to continue to grow even more.
Therefore, clearly distinguishing Equity and Balance will help you avoid mistakes that affect your trading psychology and trading results.
What does Equity mean in THE MT4 forex account?
Capital represents the value of the account in real time, reflecting how well your account is doing. When equity is greater than balance, you are trading well. Conversely, when the equity is less than the balance, it means that you have to protect yourself from risks to your account.
Equity has a direct effect on the margin call and other concepts in your forex account as follows:
- Net worth affects free margin. When there is an open position on your account, based on Equity, the system will show the remaining balance in the account that can be used to open a new order. That balance is called free margin.
Free Margin = Equity – Margin Used
- Net worth also affects the margin ratio.
Margin level = (Equity/Margin used)*100%
When the net worth is equal to the margin used, the balance to open the account is zero and the margin will be 100%. It is currently not possible to open new orders.
If your margin is less than 100%, a margin call may appear asking you to add more funds to your account or close losing trades. Suppose one of the above requirements is not met. In that case, the trade continues to lose. The margin ratio continues to decrease (usually at 30%), the broker can automatically close all your open trades. This situation is called Stop out.