Does Forex Trading Align with Sharia Principles of Investing
The foreign exchange (FX) market plays a vital role in facilitating the conversion of one currency into another. It serves various entities with diverse needs:
Multinational corporations rely on the FX market for seamless currency exchange, especially for activities like payroll management, where currencies need to be converted regularly.
Financial institutions utilize the forex markets for two primary purposes. Firstly, they engage in hedging strategies to manage and mitigate risks associated with currency fluctuations.
Secondly, they take directional bets on currency pairs, speculating on potential exchange rate movements to generate profits.
Individual traders, too, participate in currency trading within the forex market. They engage in speculative activities, aiming to profit from anticipated changes in exchange rates.
Overall, the FX market serves as a global platform where currencies are traded, meeting the diverse needs of multinational corporations, financial institutions, and individual traders seeking to exchange currencies, manage risks, and capitalize on potential opportunities presented by currency fluctuations.
This area is not as well-regulated as compared to others, so it makes it risky territory, especially for the retail investor.
The FX market does not have commissions. FX firms are dealers, not brokers. They make their money through the bid-ask spread.
How Forex (FX) trading works?
To understand how FX trading works, you need to know the differences between Retail FX vs. institutional FX.
The foreign exchange market is a decentralized global market, meaning trading does not happen on an exchange, like we see with equites which are traded through exchanges worldwide, e.g., on the London Stock Exchange.
FX trading transactions take place over-the-counter (OTC) between agreeable buyers and sellers from all over the world.
The interbank market is where most of the FX trading activity takes place. It consists of the biggest players in the FX trading market – who are the world’s largest banks, from a small group of players. Normal traders like me and you, known as retail traders, can’t access the interbank market.
This means we must access trading FX through two types of brokers. These are:
Market Maker brokers
In a nutshell, they’re not only executing your transaction, they’re the other guy you’re selling (or buying) from.
These people "make" or set both the bid and the ask prices on their systems and display them publicly on their quote screens. They are ready to complete transactions at the quoted prices to customers, that vary from retail fx traders to banks.
So not only do the market makers execute your transaction, but they are also prepared to purchase from you. When you want to sell, they can buy.
The exchange rates that market makers set are based on their own best interests. They make money by with the spread that is charged to their customers.
This is the difference between the bid and the ask price, and is often fixed by each market maker.
As counterparties, many of them will then try to hedge, or cover your order by passing it on to someone else. There are also times in which market makers may decide to hold your order and trade against you. This of course is a conflict of interest.
Electronic Communication Networks and Straight-Through-Processing (ECN & STP) brokers
They pass on prices from multiple market participants, like banks and market makers. They will then display the best bid/ask quotes on their trading platforms based on these prices.
ECN-type brokers also serve as counterparties to forex transactions, but they operate on a settlement, rather than pricing basis. They make money by charging customers a fixed commission for each transaction.
STP brokers, in a nutshell, take your trade and pass it onwards to the market and make a cut.
Is Sarf Considered to be Sharia compliant?
It is permissible when money is traded for money (Sarf) which represents the exchange of an amount in one currency for an equivalent amount in another currency; a foreign exchange transaction where both counter values must be exchanged on spot.
spot is taken to mean instant possession. Therefore, trading currencies on delayed settlement systems (eg, T+2) violates this requirement. However, since there are limited alternatives and businesses need foreign currency, this is forgiven based on the maxim ‘flexibility in case of hardship’.
The AAOIFI’s Shariah standards and can be summarised as follows:
It is permissible to trade in currencies under the following Shariah conditions:
both parties must take immediate possession (actual or constructive) of the countervalues
the countervalues of the same currency must be of equal amount the contract shall not contain any conditional option or deferment clause regarding the delivery of one or both countervalues
the dealing in currencies shall not aim to establish a monopoly position currency transactions shall not be carried out on the forward or futures market.
Investors borrow large amounts of money to make money. The same is in FX trading, they will borrow a lot of currency to make more.
However, FX traders often violate a key Islamic principle:
‘Abdullah bin ‘Amr said: ‘The Messenger of Allah -peace and prayer of Allah be upon him- said: “It is not permissible to transact a loan combined with a sale, or to stipulate two conditions in one transaction, or to make a profit on something that you do not possess, or to sell something that is not with you.” (Narrated by Abu Daud, in hadith no. 3506; the status is good).
Read more about: Halal Investment
How to FX traders violate this principle?
Currency generally does not move a lot each day, so small amounts of money will only get you so far.
However, if you use huge sums of money, that’s when you can make a lot. That’s what FX traders do, they will borrow just to bet on the currency moving.
Overall, however, there is much debate about whether this is sharia permissible.
According to Mufti Faraz Adam, retail conventional Forex trading, where individuals are merely speculating on currency pairs, is not Sharia Compliant.
Brokers which offer Islamic FX accounts advertise their product with ‘no rollover/swap fees’. What is more important to determine is whether or not there is actual trading and conversion of currencies in Islamic FX products.
Mufti Faraz argues that that retail forex practiced by private investors and speculators is a form of non-deliverable trading agreements, where delivery of the currencies never takes place.
A spot forex is an agreement to exchange a set amount of one currency for another at a predetermined exchange rate in two business days (T+2).
However people offset their open position, and then re-opening to start the new trading day. There is no “liquidating” of positions because there is nothing to actually liquidate.
Mufti Faraz gives the example of when you do a trade, it’s as if (but it actually never happens as we mentioned) you are borrowing the short currency at its overnight rate, exchanging it for the long one, and depositing that at its overnight rate. The carry is the difference between what you pay on the loan and what you receive on the deposit. When you close out your trade you reverse the process.
There are multiple products offered by conventional brokers in non-deliverable FX, such as, Contracts for Differences (CFDs), FX futures, Spread betting, FX options and Spot FX. They are of non-compliant with Shariah due to the following reasons:
2. Invalid commodity in Shariah
4. Deferred counter-values
Most people lose money when it comes to retial fx trading. You’re better of investing in stocks or look into angel investing where you can do research and have some control over where your money is going.
Image Credit: Photo by Adam Nowakowski on Unsplash