Global عربي
KSA عربي
Global عربي
Margin trading is a common practice in finance. It is ubiquitous with most brokers and stock traders across most of the world’s stock markets and derivatives exchanges.
In many ways it helps lubricate the trading volumes that most financial markets need to function.
However, like many common trading strategies, margin trading – along with short-selling and derivatives trading – is considered haram and not Shariah-compliant for a variety of reasons. We break down today what margin trading is and why it is considered haram.
Read more about: Is Short Selling Haram?
Margin trading is the use of funds borrowed by a trader to engage in trading of financial assets such as stocks, bonds, derivatives and currencies.
It is a common method used by stock traders to maximize and amplify returns on a trade.
i- When trading on margin, the trader is effectively borrowing the funds from the broker at interest. A trader opens an account with a broker and deposits a minimum required amount – dubbed a “margin.”
ii- The cash that is deposited with the broker acts as collateral for the loan to purchase the security.
iii- The trader can use this amount to borrow (usually up to 50%) of the investment’s purchase price.
v- The trader can keep this loan for as long as they want as long as the interest is paid on time. When the stock is sold, the proceeds go to the broker to cover the loan.
vi- The trader, however, has to maintain a minimum account balance – dubbed the maintenance margin – with the broker before the latter forces the trader to deposit more funds or sell off the security to pay back the loan. This is called a margin call.
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The main reason why margin trading is not considered Shariah-compliant is the use of an interest-bearing loan to purchase a security.
This is considered riba in Islam, which is prohibited. Even if no interest is charged initially, overnight positions or extended trades often incur fees labeled as "interest" or "financing costs." This constitutes riba and renders the transaction Islamically invalid.
Due to the use of leverage, margin trading is considered inherently risky. Small market movements can result in disproportionately large gains or losses.
Traders may end up losing more money than they initially invested. This puts margin trading squarely in the territory of Islamic prohibitions against gharar.
Gharar is any excessive or unnecessary speculative risk coupled with a lack of transparency.
The level of uncertainty involved in margin trading is considered gharar fahish (excessive uncertainty), which is not permissible in Islam.
Read more about: What is Gharar?
Maysir – the Arabic word for gambling or any transaction where gain comes at the expense of another's loss, with high risk and no productive economic activity – is considered haram in Islam.
Margin trades are often very short-term, speculative bets on the price movements of assets.
The trader is not investing real economic output or tangible asset but is effectively making a wager on the movement of markets. This highly speculative nature amounts to gambling.
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. They are an asset that is commonly traded on margin.
Derivatives are widely considered haram in Islam for a number of reasons. 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,” according to a paper by the Shariah Review Bureau – an organization dedicated to assessing Shariah compliance in business and finance”
- 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.
Read more about: Are Financial Derivatives Halal?
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
