Distinguishing Between Balance, Equity And Free Margin In Forex Trading

Continuing the lesson on Balance in Forex, in today’s article, Finance Solutes will help you explore and distinguish between the 3 most common terms in the forex market: Balance, Equity, and Free Margin. Let’s get started!!!

1. BALANCE

1.1. What is Balance?

As mentioned in the previous lesson, when you have no open positions, Balance is the total amount of money available in your trading account.

This means that if you have a $2000 account and no open trading positions, your Balance remains at $2000.

1.2. Real-life Example

Finance Solutes will reuse the real-life example from the previous lesson. For instance, when you open a forex trading account, the initial Balance is $0. After you deposit $2000, your Balance will increase to $2000.

So, Balance is the total amount of money you have in your account before entering any position. When you have an open position and the profit/loss of that position fluctuates as the market moves, your Balance remains the same as before opening the position. Once you close the position, the profit/loss will be added/subtracted to/from your account balance, and the new Balance will be displayed.

Pretty easy to understand, right???

2. EQUITY

2.1. What is Equity?

Equity (used for capital management and risk of margin call) is your account Balance plus the floating profit/loss of your open positions.

Equity = Balance + Floating Profit/Loss

When you have no open positions and therefore no floating profit/loss, your Equity and Balance will be the same.

2.2. Real-life Example

Example 1: If you don’t have any open trades, your Equity is exactly the same as your account Balance.

You deposit $1,000 into your trading account. Since you haven’t opened any trades yet, your Equity and Balance are equal.

Example 2: If you open positions, your Equity will equal the sum of your account Balance and the unrealized profit/loss on your open trades.

You deposit $1,000 into your trading account.

A famous singer tweets that she’s selling GBP/USD. You follow her lead and also sell GBP/USD. At that very moment, the price moves against your expectation; your trade shows an unrealized loss of $50.

Equity = Account Balance + Unrealized Profit (or Loss)
= $1,000 + (-$50) = $950

So, the current Equity in your trading account is $950.

The singer then tweets that she changed her mind and is now buying GBP/USD. You follow her again and also buy the GBP/USD pair. The price immediately moves in your favor; this trade gives you an unrealized profit of $100.

Equity = Account Balance + Unrealized Profit (or Loss)
= $1,000 + $100 = $1,100

So, the current Equity in your trading account is $1,100.

So, as long as you have open positions, your Equity will continue to fluctuate with market prices.

Equity only shows you the temporary value of your account at that specific moment. That’s why Equity is considered a “floating account balance.” It only becomes your “actual account balance” when you close all trades immediately.

3. FREE MARGIN

3.1. What is Free Margin?

Free Margin is the amount of money not currently being used in any trade, and you can use it to open additional positions.

Another way to understand this concept: it’s the available cash in your account that traders can use for new positions.

Free Margin is the difference between Equity and Margin (used for open positions).

3.2. Real-life Example

This can be explained with the following example:

Equity: $10,000

Margin used for current position (Margin Trading): $8,000

Free Margin = Equity – Margin used for open positions

=> Free Margin = $10,000 – $8,000
=> Free Margin = $2,000

So, when you have no open positions, that means none of your account funds are being used as margin. Therefore, all the money in your account is considered Free Margin. As long as you have no open positions, your Equity and Free Margin will be the same as your Balance.

4. SUMMARY

So, through today’s article, Finance Solutes has provided you with the most detailed explanation and comparison of the three most common terms in Forex trading. Hopefully, the knowledge shared in this article has helped you understand them more clearly and see the differences between these three terms.

Wishing you success in your trading journey!!!