Equity Definition: Equity is the value of ownership that remains after all debts are subtracted from the value of an asset, calculated as assets minus liabilities. In markets it most often means ownership in a company, held through shares, while in a trading account it means your balance plus or minus the profit or loss on open positions.
What Is Equity?
Suppose you buy a $400,000 house with a $100,000 deposit and a $300,000 mortgage. You live in a $400,000 house, but you own only $100,000 of it. That $100,000 is your equity, and every idea behind the word follows the same subtraction: what something is worth, minus what you owe against it.
Companies work the same way. A business owns factories, cash and patents, and it owes money to banks, bondholders and suppliers. What is left over belongs to the owners, and that leftover is split into shares. Buy one share and you own a small slice of the company’s equity, which is why stocks are often called “equities.”
Owners are paid last. If a company is wound up, lenders get their money back first and shareholders receive whatever remains, which may be nothing. In exchange for standing at the back of the line, equity holders keep all the upside. There is no cap on how much a share can rise, while a lender only ever receives the agreed interest.
How Does Equity Work?
The formula is the same in every setting: equity equals assets minus liabilities. What changes is how often the numbers move. A company reports its shareholders’ equity, also called book value, once a quarter on its balance sheet. A trading account recalculates equity with every price tick.
Start with a company that has $500 million in assets and $300 million in debts, which leaves $200 million of equity. With 10 million shares outstanding, the book value per share is $20.
If the stock trades at $60, investors are paying three times book value, betting that future profits will be worth far more than the assets on paper. That gap between book and market value is the starting point of stock valuation.
Now take a trading account. You deposit $5,000 and open a long position on gold using leverage, with $1,000 set aside as margin. Your balance is $5,000 and so is your equity, because nothing has moved yet.
Gold then falls, and the open trade shows a loss of $1,200. Your balance is still $5,000, since the trade is not closed, but your equity drops to $3,800. The broker watches equity, not balance. If losses push equity close to the margin set aside, the broker issues a margin call or closes the position automatically, because equity is the only cushion that protects it from your losses.
Types of Equity
- Shareholders’ equity: a company’s assets minus its liabilities, as shown on the balance sheet.
- Market equity: the share price multiplied by the number of shares, which is the value investors place on the company’s ownership.
- Private equity: ownership stakes in companies that are not listed on an exchange, usually held by specialist funds.
- Home equity: the market value of a property minus the mortgage owed on it.
- Account equity: a trader’s balance plus or minus the unrealised profit or loss on open positions.
Why Is Equity Important for Traders?
Equity is the buffer that absorbs losses, and the thinner it is, the less room for error you have. Leverage shrinks that buffer. A company or trader financed mostly with debt can see its equity wiped out by a small fall in asset values, while the same fall barely dents an owner who used no borrowed money.
Lehman Brothers showed how fast that works. By the end of 2007 the bank held about $30 of assets for every $1 of equity. At that ratio, a drop of just over 3% in the value of its assets was enough to erase shareholders’ equity entirely. When the value of its mortgage holdings fell in 2008, lenders stopped rolling over its short-term funding, and the bank filed for bankruptcy in September 2008 with its shares close to worthless.
Book equity also has limits as a measure. It records assets at historical cost, so a software company with valuable code and brands can show little equity on paper, while a bank’s book value can hide losses on loans it has not yet written down. That is why traders compare book value with market value rather than treating either number as the truth.
Equity vs. Debt
| Equity | Debt | |
|---|---|---|
| What you hold | Ownership stake | A loan to the issuer |
| Return | Dividends and price gains, no cap | Fixed interest, capped at the agreed rate |
| Priority in bankruptcy | Paid last | Paid before shareholders |
| Voting rights | Usually yes | No |
| Typical instrument | Common stock | Corporate or government bond |
Companies choose between the two when they raise money. Borrowing keeps ownership intact but adds fixed payments that must be met in bad years. Issuing new shares avoids that burden but dilutes existing owners, since the same profits are split across more shares. Investors reward the choice differently too: equity holders demand a higher expected return than lenders because they carry more risk.
Key Takeaways
- Equity is ownership after debts, calculated in every setting as assets minus liabilities.
- Shares are units of a company’s equity, which is why stocks are commonly called equities.
- In a trading account, equity equals the balance plus or minus open profit and loss, and brokers use it to decide when to issue margin calls.
- Leverage shrinks the equity cushion, so a small fall in asset values can wipe out owners who financed their positions mostly with debt.
- Equity holders are paid last in bankruptcy but keep unlimited upside, while lenders are paid first and receive only fixed interest.
Is equity the same as stock?
In everyday market language, yes. "Equities" is a common name for stocks, because each share is a unit of ownership in a company's equity. Equity is the broader idea, though, and also applies to private companies, property and trading accounts.
Can equity be negative?
Yes. A company whose liabilities exceed its assets has negative shareholders' equity, and a trading account can briefly show negative equity if a fast market moves through the stop-out level. Many retail brokers in Europe and elsewhere offer negative balance protection to reset such accounts to zero.
What is the difference between balance and equity in a trading account?
Balance counts only closed trades and deposits. Equity adds the profit or loss on positions that are still open, so it changes with every tick while the balance stays fixed until you close a trade.
What is return on equity?
Return on equity, or ROE, is a company's net profit divided by its shareholders' equity. A business that earns $20 million on $100 million of equity has an ROE of 20%, which shows how efficiently it turns owners' capital into profit.
