Explaining a Trading Account

One of the most important decisions a trader must take, besides choosing which Forex broker to trade with, is the type of the trading account. There are many account types offered by various brokers, and they give an insight into the way the brokerage house is organised. Conditions offered in a trading account differ based on the type of the broker: dealing-desk brokers offer different conditions from non-dealing-desk ones, and Electronic Communication Network (ECN) or Straight Through Processing (STP) brokers have other types of trading accounts. However, the way to deal with al these trading accounts is the same, as there are only a few things to consider. Because the most popular trading platform is the MetaTrader 4, we’re going to use it for showing the things to know about a trading account. The most important of these are listed below.

Elements of a Trading Account

Explaining a Trading Account - 1There are three elements that are part of any trading account, regardless of the trading platform. These are balance, equity, and free margin.

Balance

The balance of a trading account represents the total value of it, without considering any open trades that might exist. If there is no open trade, all three elements – balance, equity and the free margin – will show the same value, meaning the amount the account is funded with. However, after opening a trade, things become a bit more difficult to interpret. While the balance tab will always show the same value, except as a trade is opened and closed, the other elements will change. This can have a terrible psychological effect on traders, as there is a strong tendency for the balance to be the one considered as showing the value of a trading account. That is totally wrong! The one thing that matter for a trading account, or the one thing that shows the true state of it, is the equity. So, if anything, traders should focus on increasing the equity, not the balance, of a trading account.

* T&Cs apply to each of the offers. Click “Trade” for more details

Equity

Equity shows the real value of a trading account at any moment in time, no matter whether there are positions opened or not. Even the number of opened positions is not important, as the value of the equity  adjusts automatically, based on that number and the way the positions are fluctuating in the market.

Typically, the equity in a trading account shows the profit that is not yet booked (in this case, the equity value is bigger than the balance value) or the loss that is not yet marked (in this case, equity is smaller than balance). As a rule of thumb, the bigger the equity, the more profitable the trading account is.

Free Margin

Before opening any trade, the free margin shows the amount in a trading account that can be used for trading. If a trade is open, that free margin will show the difference between the total amount minus the margin blocked in trades. Depending on the volume and the currency pair traded, the margin needed for the trade can vary. When there is no free margin left, it is no longer possible to open any new trade. To achieve a free margin, either some open trades must be closed, or new funds must be deposited in the trading account. In a way, the free margin is a reality check for the trading account, as the more it decreases, the riskier trading becomes, and the greater the chance of the account being blown. The image above is part of a demo trading account, and shows what the account looks like before opening a trade; or, how the account looks immediately after it is funded. The moment a trade is opened, some other elements come into play, as can be seen in the image below. As an example, I sold a EUR/USD position, to see what other elements must be considered.
Explaining a Trading Account - 2

Entry, Stop Loss and Take Profit Level

These are the three levels that define any trade. It is mandatory to have a stop loss (the level at which the trade or analysis doesn’t make sense anymore), or a take profit (the target or level the price must reach for the analysis to be right) order for any trade. This shows that a plan was in place and eliminates the risk of the account being depleted. Risk management and money management are key to growing the equity of a trading account. There is the possibility that those lines/levels are not shown on a chart, but it is strongly recommended if more trades are open on the same currency pair at any one time; otherwise, the chart becomes too crowded.

Other Things to Interpret

Explaining a Trading Account - 3
The moment a trade is opened, there are several other things to consider. The trade I mentioned above was a short EUR/USD trade, the position size or volume is 0.5 (half a standard lot), and the direction is short (sell). There is a ticker associated with every trade that is taken. The idea behind this is that traders can go and track down each trade based on that ticker number (Order, the first column on the image above). Moreover, the date appears as well, stating both the calendar date and the time the trade was opened. Stop loss and take profit are part of any report, as well as the entry level. A short description of the trade listed above will look like this: We went short at market 0.5 lots EUR/USD at 1.07458, with 1.0800 stop loss and 1.06450 take profit. If the stop loss is reached, the trade ends with a loss that will be deducted from the balance of the trading account. If, on the other hand, the take profit is hit, the balance will increase by the corresponding amount. In both cases, though, the margin blocked for the trade will be released and become free margin.

The commission tab shows the broker’s fee for opening this trade. This increases or decreases with the volume traded, and it is always deducted from the trading account at the very moment a trade is opened. Attention: It is deducted from the equity, not balance. Again, equity reflects the true state of a trading account. The swap tab will show a positive or negative amount that will be added or deducted from, again, the equity value, at the end of each trading day. When positions are rolled over into the next trading day, the interest rate differential between the two currencies that make the currency pair will result in a positive or negative swap. Finally, the margin level shows the margin percentage still available for taking new trades. It is just another tool for traders to consider when interpreting the state of a trading account.

All the elements listed in this article are part of the state of the trading account and, more importantly, are used in setting the risk for the account. A sound money management plan must always consider the state of the trading account, regardless of the trading strategy used.

.

Recommended Further Reading

Other Educational Materials