Account Equity

Equity in the account is one of the most important terms that every Investor and trader must know. Though the concept of this term, any account forex market with respect to good investors has always necessarily acknowledged his own money and trading capacities. In this blog, you will learn what account equity is, how it works, and why, as an investor, you should be concerned about Account Equity. 

Investors who understand account equity will better understand ​​how to make the right decision, control risk, and not be surprised by any sudden market movement against investment positions. Let’s get into the specifics for easy, simple account equity explanations. 

What is Account Equity? 

Account equity, in trading and investment, is the total value of the investor’s account at any given time. The net amount of all cash and securities can be converted into cash, including the unrealised profits or losses from open positions and folios held in a currency. That is the combined value of all holdings in your account. 

An example would be where one has US$20,000 in cash (no loan), securities worth US$ 30,000, and an unrealised profit of open trades at US$2,000; the account equity would hence be: US$52,000 

Account equity is constantly changing as a live measurement based on the investor’s open trade positions, market movements, and other factors; hence, it serves as an indication of overall economic health at any given time. 

Understanding Account Equity 

Knowledge of account equity is essential because it allows one to determine a trader’s buying and selling capacity of securities or any other financial instruments. The total amount comprises your cash, investments, and profit/loss pending in your open positions. 

Main Components of Account Equity 

• Cash Balance: This is the liquid cash in your account that you can use to purchase securities or withdraw money. 

• Securities Value: Total value of investments you hold in your account. 

• Unrealised Gains or Losses: This is a representation of profit and loss generated by open trades that have not yet been realised—the trade has not been closed. 

Account equity, also known as net worth, can be rather volatile, in particular for unstable markets. When the securities in your account lose value or when open positions move against you, your account equity will depreciate. Of course, the opposite happens when the price of your investments rises: the account equity appreciates accordingly. 

Risk Exposure of Account Equity 

In trading and investment, account equity is one of the most critical measures responsible for accurately measuring risk management. It is directly related to the quantum of risk a trader is carrying, thereby helping him know what he can afford in terms of profit or losses with respect to the current position. 

Leverage and Margin 

Leverage: The major risk linked to account equity is leverage. The power of leverage is such that an investor is able to control a position that size for, essentially, a fraction of its total value due to the low-cost basis associated with said instrument. In that case, leverage increases profits, but it also increases the risk of profound loss to the investment. In fact, the fact that the margin of borrowed money is used to supercharge that account equity only makes it more likely that cutoffs like what happened on October 19th will occur. 

To put it in perspective, if a trader is looking to buy US$50,000 of stock on margin, using no more than US$25,000 of his or her money, when the security loses 10% of its value, that could be as high as US$5,000. Such would represent a 20% reduction in the trader’s account equity- a decent example of how leveraging amplifies one’s risk.  

Margin Calls 

When account equity goes below this threshold, termed the maintenance margin, this situation is called a margin call. Thus, in case of a margin call, an investor should deposit more funds to return his account equity or risk liquidation by the broker. 

To avoid margin calls, the most important thing is to closely monitor your account equity, especially when trading on margin. 

Calculation of Account Equity 

Account equity is simply a sum of the following three elements combined: 

1. Cash Balance: Cash balance available.
2. Market Value of Securities: The current value of existing stocks and bonds.
3. Unrealised Gains or Losses: The current value of open positions minus what the latter was worth when they were opened.

The account equity is calculated by the formula as stated below: 

Account Equity = Cash Balance + Market Value of Securities + Unrealised Gains/Losses 

Example : 

Now, let us assume a specific scenario in which there is a trader whose account consists of the following items: 

Cash balance = US$15,000 

Stocks valued at US$35,000 

There is an unrealised profit of US$5,000 from open trades. 

The account equity of that specific trader will be : 

Account Equity = US$15,000 + US$35,000 + US$5,000 = US$55,000 

This is the total sum of the value in the trader’s account as on the total of his realised and unrealised gains. 

Examples of Account Equity 

Let’s take a few examples to understand how account equity works practically. 

1: Stock Trading (US Market) 

For example, imagine an investor in the US who has USD 10,000 in cash and wants to buy shares of Apple worth USD 30,000 on margin. The investor currently owns Apple shares and has assumed debt to buy them. Therefore, if Apple goes up and hits 35,000 after the investment is made in shares, the investor’s account equity will rise to 15,000 + 35,000 = 50,000. Then, as the share price drops, so too will the investor’s account equity. 

2: Forex Trading-Singapore Market: Now, let’s say that the cash balance in a Singapore-based forex trading account is US$ 20,000, and he takes leverage to open positions for US$/SGD currency pairs. If the trade happens to be in favour of the trader, he might even get an unrealized profit of US$ 5,000. His account equity would now be US$ 20,000 + US$ 5,000 = US$ 25,000. However, if the trade is against him, his account equity may fall, and thereby, he may receive a margin call.

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