Why many common securities trading strategies are considered haram?

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Funding Souq Editorial Team
Tech Writer
May 26, 2024
Funding Souq’s editorial team comprises experienced finance and investment professionals that are on a mission to fuel SME growth, create jobs, and drive the economy forward. They aim to share their extensive experience and industry know-how to empower entrepreneurs and investors alike.
May 26, 2024
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Trading equities (or any security) in Islam is a complicated subject, primarily because the threshold for what is considered a legitimate security to trade in from the Shariah-compliant sense is:

a- much more stringent

b- the trading strategies commonly used by hedge funds and other investors are not permissible.

c- the lack of uniform guidelines in Islam concerning these strategies. 

This largely falls down to the use of debt (and interest) – considered Riba in Islam – and the speculative nature of securities trading, which in many instances is considered Gharar.

Furthermore, depending on the strategy (or lack thereof), some might even consider it a form of gambling (Maysir).

Today, we look at some common strategies used in securities trading and explore why they are largely forbidden in Islam. 

1-Short-Selling


What is Short-selling?


Short-selling is a strategy by which an investor makes money off the value of a stock falling. It involves borrowing or renting shares on interest and then the sale of the stock when the price remains high. If the price declines, the investor buys back the stock at the lower price, then returns it to the lender, while pocketing the difference.

How and why short-selling is haram?



Short-selling is forbidden in Islam for two main reasons. The first is that it involves the borrowing of shares with interest (riba). The second reason is that it involves the sale of a good that one does not own, which is a violation of a key principle in Islamic commerce, according to Humayon Dar,

the director general of the Cambridge Institute of Islamic Finance and former CEO of BMB Islamic, a Shariah advisory firm.

Short-selling is also much riskier as losses from a short position can be infinite, depending on when the investor buys back the stock. This could potentially place it in the realm of gharar – or engaging in highly risky or fundamentally speculative trading.

2- Margin trading


What is margin trading?

Simply put, margin trading is the use of funds borrowed by a broker to engage in trading of financial assets such as stocks. It is a common method used by stock traders to maximize and amplify returns on a trade.

 

How and why margin tragding is haram?


As with short-selling, it involves borrowing at interest, which violates riba laws, according to Dr Faleel Jamaleldeen, Executive Director and Assistant Professor at Geneva School of Business and Economics, and author of Islamic Finance for Dummies. And as with short-selling, the potential losses could far exceed the amount borrowed.

 

3- Day trading


What is day trading?

Day trading – a common strategy among retail investors and hedge funds alike – is a strategy that involves the buying and selling of securities within the same day.

It is a high-paced strategy that focuses on technical analysis, which focuses on past prices and trends to predict future prices, and momentum analysis, which hopes to piggyback off of short-term gains and trends. 


How and why day trading is haram?


While the returns on day trading can be highly lucrative, day trading is among the most speculative and riskiest trading strategies out there. This puts them squarely in gharar territory and potentially even in gambling territory,

as daily volatility and shifts in the market are unpredictable no matter how much technical and momentum analysis goes into the stock picks. Furthermore, scholars, including
Sheikh Yusuf Talal DeLorenzo, question whether owning a stock for a single day constitutes real ownership. As noted above, this would violate prohibitions in Hadith on the buying and selling of goods that one does not own.

 

4- Derivatives trading


What are derivatives trading?

 

Derivatives are financial securities that derive their value from an underlying asset. Notable examples include futures contracts, whose value comes from the underlying commodity price, and in the case of equities and stocks, these include options (calls and puts), forwards and swaps.

 

How and why derivatives trading are  haram?

 
Derivatives are widely considered haram in Islam for breaking guidelines on Gharar and Maysir. Depending on the derivative, they also break with other key principles in Islam, according to 
a paper by the Shariah Review Bureau – an organization dedicated to assessing Shariah compliance in business and finance. These include:

·      - Futures contracts see the deferment of both pricing and delivery of goods to a later date. “A sale is only valid under Shariah law as long as only the price or delivery, but not both, is postponed.”

·     -  Derivatives contracts can exchange hands and be traded without the underlying good having changed hands. This violates a key principle in Islamic commerce, which forbids the sale of a good that one does not own.

·     When it comes to options – which is the right to buy or sell a stock at a future date – placing fees on their trade is forbidden in Islam. 

 



Disclamer:

" Funding Souq Limited (DIFC) is regulated by DFSA. Funding Souq operates an Islamic Window. This content is not reviewed by the Firm's Shariah Supervisory Board, it is for educational purposes only, and the Firm does not directly or indirectly provide these services."

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