Understanding Equity & Account balance
Understanding equity and account balance is a very important part in trading. When we're talking about equity and account balance, we're talking about two different parts of our trading account. Equity is what our account is carrying in either positive or negative balance. Account balance is what our account currently sits at in total. Being able to distance yourself from equity and account balance is highly important, we're going to talk about that more now.
Another part of trading is, as crazy as it sounds, is distance yourself from the daily P/L (profit & loss.) Your account balance may be negative however your equity may be positive, if you're consistently rebalancing your trading portfolio on daily P/L, you'll have a tough time keeping up. Your account may be negative however equity may be positive. Still confused? Read on...
Take a look at these two graphs. One represents account balance while the other represents equity balance. You'll notice the account balance graph is currently in drawdown while the equity graph is in positive territory. If you were to close all your open trades (equity) your account would come out of negative balance into positive balance.
One of the biggest struggles most traders will face in their trading career is being comfortable while your account balance is in the negative (drawdown) and holding equity and letting your equity build to keep a positive portfolio once those trades are closed. However, it's extremely important to be able to distance yourself from the daily P/L (account balance) to the equity. All though your account is technically in positive territory it's hard psychologically to be able to understand and be comfortable with holding your positive trades long enough for them to build back the account balance into the positive while also generating profit on top of that.
This is a large part of understanding trend following and understanding how it works, once a trader can distance themselves from this aspect of trading (P/L) a trader can dramatically increase his or hers trading performance. One core ability of many successful traders is not getting caught up within the daily profit and loss of their account, and knowing capital preservation is a key part of trading while simultaneously knowing how to grow their account balance.
Ready to start getting comfortable with your account balance and equity?
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