Forex Trading Terms – Margin, Account Balance, Equity, Floating P/L
Margin is the sum of money a trader must contribute in order to execute and hold a position. It is a security deposit that the broker maintains while a forex trade is open. Margin is not a transaction fee. For instance, if you want to purchase $100,000 worth of USD/EUR, you only need to provide a fraction of the money, say $3,000, rather than the entire amount.
The forex broker or CFD provider determines the precise margin amount. This $3000 margin may not be sufficient to cover your losses if the market moves against you because it represents a very tiny portion of the total value of your investment. After that, you must keep an eye on your maintenance margin.
A broker provides 1:20 leverage for Forex trading. In essence, this means that 1 unit of currency must be used as the margin for every 20 units of currency that are present in an open position. In other words, the margin would be $1 if the amount of your planned forex position was $20.
As a result, the margin, in this case, is 1/20 or 5%. To show this the other way around, if a broker requested a 10% margin, we could figure out that we would need to provide $1 in margin for every $10 we wanted to trade. In this case, we might leverage our transaction at a ratio of 1:10.
Also, the total amount of money that the broker has set aside as a margin to support several positions is referred to as the used margin. Since using margin to take on larger holdings can be beneficial, trading forex on margin is a common approach. But it’s equally crucial to realize that trading on margin will also result in larger losses. Prior to trading on the foreign exchange market with leverage, traders should take the time to learn how the margin functions.
The balance of a trader’s trading account represents their available funds, excluding any open positions. If you deposit $2,000, then your account balance is $2,000. Only profit or loss from positions that have been closed are reflected in the balance. The balance excludes the margin and open positions. If you leave a transaction open overnight, swaps and rollover fees have an impact on your account balance.
In forex trading, the swap is a charge or interest rate that a trader either pays or receives for keeping a position open throughout the course of the night. If you are paid, the swap will be added to your account; if you are charged, it will be subtracted. Swap costs are often negligible, but they can build up if you trade regularly or if you hold the trade for longer.
Equity shows the trading account’s current value and varies in response to changes in open deals. It consists of the account balance plus any unrealized gains or losses from open positions. Equity also accounts for trading expenses like commissions and swaps. The current value of your equity rises when profits are made on your open positions. The value of your equity decreases, on the other hand, when losses are realized on any open holdings. Your equity is equivalent to the balance of your trading account when there are no open trades. Thus, the formula for finding equity is:
Equity = Account balance + current value of the opened positions + swap – broker’s commission.
Equity depicts the state of all open positions held by a trader. You can determine free margin, which you could utilize to place new trades, by deducting the margin from the equity. The broker will initially notify you that you need to top up your balance if there is not enough free margin to keep the positions open. If you disregard this warning and the market moves against you, the broker will compel you to close all of your positions.
Difference between Account Balance and Equity
Without accounting for any open positions’ profit or loss, the account balance shows the funds you currently have in your account. Your balance, less the floating profit or loss from your open positions, is your equity. The main differentiation between forex account balance and equity is that open positions are not included in the account balance. On the other hand, equity includes all recent changes in trading positions.
As a result, equity is a floating value that is subject to fluctuation at different points in time. When open transactions are losing money or when profits are less to compensate the broker’s swap and commission, equity is typically lower than balance. On the other hand, when trades are already profitable, and trading costs have exceeded the profits, equity is larger than balance.
The profit or loss a trader experiences while holding an open position is known as floating profit or loss. It is also known as unrealized P/L. It alters because it does so in response to the open positions. A trader can monitor the performance of his open positions and determine when to close them with the help of floating profit or loss. This indicator stops changing once all positions are closed and displays the trader’s fixed deposit. The formula for floating P/L is:
Floating P/L = Position Size x (Current Price – Entry Price)
Let’s take an example.
Your trading account is in USD, and you are currently long 10,000 units EUR/USD, which was purchased at 1.25
The current exchange rate for EUR/USD is 1.13.
Floating P/L = Position Size x (Current Price – Entry Price)
= 10,000 x (1.13 – 1.25)
This means that the position is down 1200 pips. The floating loss is $1200 (1200 pips x $1), and the position is not closed yet.
For the same scenario, If EUR/USD rises above your original entry price to 1.30, then it will be a Floating Profit. The position is now up 500 pips. The floating profit is $500 (500 pips x $1).
For the traders to execute the trades and avoid any hurdle, it’s very crucial to understand the basic terms related to forex trading. The margin, account balance, equity, and floating P/L are the terms associated with the trading account. Without understanding these terms, traders can’t begin with their trades. Furthermore, the traders also need to clear the difference between the account balance and equity in order to avoid confusion.