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In a previous entry, we looked at some common securities trading strategies and explored how and why some of these strategies are considered “haram.” Just because these and more are largely considered by scholars to be forbidden shouldn’t put you off of trading as there are also strategies that are shariah-compliant.
Check our previous entry about: Why Common Security Trading Strategies Are Considered Haram?
Today, we look at some common strategies that are shariah-compliant and how an Islamic-minded investor can better achieve them.
Remember: Shariah-compliant securities trading has to be meet certain qualifications:
· - Ensuring that what you are trading in is shariah-compliant. In the case of equities and stocks, there are rules to ensure that the stock of a particular company is halal, which we’ve looked at here.
· - Trading must absolutely avoid the use of interest-bearing debt (riba).
- The trading strategy employed must not be overly risky or wholly speculative (gharar) or gambling (maysir).
· - And finally, one must avoid buying or selling of goods that they do not actually own, as is the case with short-selling.
Before any investor can look at an asset to trade or a strategy to follow, they must first assess and determine what financial goal they hope to achieve.
These can range from generating wealth, to making an income from the investment, or hedging against inflation. Once that’s figured out, an investor must determine how much they would like to make from an investment.
The investor must determine the timeframe for that investment. Knowing when to enter and when to exit and figuring out whether the strategy is a long-term strategy or a short-term one is a crucial step when deciding on an investment.
Then there’s the risk appetite for the investor. Any investment has an inherent risk, but these differ depending on the asset, project, or strategy involved. A prudent investor must decide on how much they are willing to risk on an investment and how much they would like to see a return on them, bearing in mind the higher the risk, the higher the return (and the higher the loss).
And finally, the investor must determine how involved they would like to be. Active investors will seek, analyze and research their investment and there are strategies ideal for those, while passive investors would like to park their investment in an asset offering steady returns.
With that in mind, let’s look at some common shariah-compliant strategies used by securities traders.
Choosing the right instrument for an investor’s risk appetite is a crucial first step. Sukuk for instances, are considered much more secure and less risky than stocks (depending on the company),
which can change day-to-day. Similarly, certain stocks are safer than others and are considered more stable. That’s based on their underlying historical performance of the stock, as well as the company’s size and activity.
Examples of such stocks include the major tech stocks such as Microsoft, Amazon, Nvidia and Alphabet. However, because their relative security, these stocks are essentially expensive to buy and the returns may not be as high.
A very common method for retail investors who have a low risk appetite and are looking for something more passive is to invest in exchange traded funds (ETFs).
A retail investor will invest in an ETF that tracks an exchange or an industry, and that investment will be distributed across that exchange or industry’s constituent stocks.
ETFs allow an investor to hedge against a single declining stock by essentially distributing the investment across the entire constituency of an exchange. It also allows for passive income as it is inherently less risky than putting most of the eggs in a few baskets, making them very popular among first time investors.
And with the emergence of shariah-compliant ETFs, one does not need to constantly track the activities of constituent companies to see if they adhere to Islamic principles.
Read more about: How Can Muslim Investor Choose The Right ETFs?
Both growth and value investing seek to capitalize on the missed opportunities by the market.
Growth Investing
In the case of growth investing, an investor will seek out a relatively small company that has the potential to outgrow the market by orders of magnitude.
These are usually companies in emerging technologies with potential for scale or ones that provide solutions to very difficult problems for an industry. While correctly finding these companies can be very lucrative, they also come with an inherent risk: this aren’t yet company that has proven themselves and by virtue of their relatively small size, could fail for any number of reasons.
Value Investing
Value investing is very similar, except that it will look for companies that are undervalued and looks to capitalize on the potential growth in the company’s valuation. These are usually well-run companies, with proven capabilities that for some reason or another the market just hasn’t caught on to them.
This strategy is for the more active investor, usually one that is highly adept at analyzing a company’s performance and capturing growth and value opportunities that the market does not see, which requires a great degree of sophistication. This will require analyzing a company’s financials, earnings, strategy, and the fundamentals of its business and its exposure to the overall market.
Return on equities comes in two forms: capital gains from the resale of a stock or the dividends that the company pays to shareholders from the company’s profits. Dividend investing hopes to lock in the latter, by investing in companies that regularly payout dividends.
Not all companies payout dividends. High growth companies have a tendency to reinvest their earnings into the company. Companies that pay out a dividend are usually well-established that generate consistent income that don't see much need to reinvest all of its profits back into operations.
For this strategy to work one must look for a company that regularly pays out dividends at a reasonable portion of the share price. Be weary of companies that offer major payouts as they might be overly eager to attract investors.
Learn more about: Halal Dividend Investment
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
