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Forex Trading - Halal or Haram Fatwa
Usury is of course completely prohibited in Islam, and is defined very widely. This implies that any kind of deal or contract which involves an element of interest (riba) is not permissible according to the Quran.
Islamic Forex Brokers
For a long time, retail Forex brokers reflected the market practice of paying or charging to the trader the interest differential between the two components of any currency pair whose position remains open overnight. Eventually, most Forex brokers responded to market forces (and pressure from Islamic traders) by becoming “Islamic Forex Brokers” and offering “Muslim Forex Accounts” which operate without standard interest payments. You might ask how they did so and maintained the profitability of their operations. This was achieved by charging increased commissions in spot Forex trades, and this practice has become the hallmark of nearly all Islamic Forex brokers. Arguably, this in itself is just a camouflaged interest component, and if this view is taken, it makes Forex trading problematic according to Islamic law.
The interest problem also eliminates any possibility of trading Forex forwards, as there is always an interest element involved in these transactions.
However, “regular” spot Forex trading offered by Forex brokers, with no overnight interest payments or charges, could clear the hurdle of riba.
What is an Islamic Swap Free (Halal) Account?
An Islamic swap-free account is a type of trading account provided by most Forex / CFD brokers. It is an attempt to give observant Muslims a halal way to trade Forex and CFDs. The defining feature of Islamic accounts is that they neither charge nor pay to the account holder overnight swap fees, which are usual in Forex, and are calculated based upon tom/next rates which in turn are based upon the differential interest rates which central banks are paying for their currencies.
What Islam Says on Online Forex Trading
Having reduced the issue to one of trading spot Forex and assuming there is no interest element deemed to be involved, we move onto the next issue. It would seem to be permissible only “so long as it is hand to hand”. So clearly, the Prophet Mohammed (peace be upon him) had in mind exchanges of different types of commodities that would be made between two parties, recognizing that this was a natural and just aspect of commerce. The question here lies in what is considered to be “hand to hand”.
What Qualifies as "Hand to Hand"?
In the olden days, there were of course no computers or telephones, so the aspect of making a deal face to face (or hand to hand) wasn’t much of a question. In fact, one could extrapolate that it was natural and accepted for a deal to made between two different parties. In modern times, it can be argued that in regards to Forex trading, the deal is made between a Forex broker and a trader, so this would qualify under such a definition of two different parties, which would be permissible according to Islamic law.
A further widely recognized stipulation is that the actual exchange must take place during the same “sitting” in which the contract is made- in other words, trades must be concluded more or less immediately. We would seem to be on solid ground here, as when a trade is made with a Forex broker, it takes effect immediately. Interestingly, this could suggest that all non-market trades (i.e. stop or limit orders) are haram!
Speculating vs. Buying
It is here that we arrive at the biggest hurdle in attempting to answer the question “Is Forex halal or haram?” Generally, Forex traders do not expect to take actual delivery of the currency they are “buying”, and never actually own the currency that they are “selling”. They are simply speculating that the value of one with go up and the value of another will go down. Is such speculation permissible according to Islamic law?
This is an extremely difficult question to answer and it may be one that should be discussed with your own religious leader rather than being decided base on an internet article. Nevertheless, we’ve researched the issue thoroughly and will be outlining some points of thought below.
We can start by saying that Islam recognizes that nearly all adult human beings strive to improve their financial positions, and that life involves a large element of uncertainty. In life we are confronted with many choices, the outcome of which is unclear, and we strive to use intelligence and skill in choosing the available option that will produce the superior outcome. However, we then must go on to say that gambling is strictly forbidden by Islamic law, even as a form of recreation or entertainment when undertaken with small monies which the gambler might be said to be able to afford to lose.
In measuring these two competing elements, it can be said that it is the method of speculation that makes the difference. One author has examined the subject and stated that speculation on the basis of fundamental analysis is permissible, but technical analysis is not, and an interesting reasoning is given: placing trades based on technical analysis is essentially tantamount to betting on the bets of others, and relying upon the behavior of the crowd to influence your speculation is drenched with the essence of gambling, which is forbidden by Islamic law.
However, this argument can certainly be criticized as spurious as related to market realities. For example, is a speculator who believes that the U.S. Dollar will rise against his Euros due to economic fundamentals bound to simply make the trade immediately, and forbidden to take any action to time the trade entry to a psychologically opportune moment?
A stronger argument could be made that a Muslim has no business speculating on the currency markets unless he or she has a firm basis upon which to anticipate success. This would mean that trades must involve either some element of fundamental analysis or technical analysis which the trader actually has a firm reason to believe in. One example might be trend following trends that have an academically established track record as a profitable trading method in liquid financial markets, and trading these trends using Islamic FX Brokers. A trader could argue that a strong technical trend is easier to establish – and is also likely to have an underlying (if invisible) “fundamental” reason behind it - than a classical fundamental economic outlook which might be disputed by professional economists!
Creating a Muslim Forex Account
There is no question that currency exchange is permissible in Islam, provided that there is no interest element, that it is made hand to hand (though this phrase can be translated in multiple ways), and that the exchanger has a valid reason to anticipate a probable profit based upon an analysis that does not rely upon the psychology of gambling. On a minimal basis, Islamic Forex brokers can be used to trade, which should at least remove arguably all of the riba challenges. As we have seen, there are certain grey areas within this qualification that must be investigated deeply in good faith and conscience by anyone wishing to begin halal Forex trading with a Muslim Forex account.
Short Selling in Islam
A further issue that tends to cause a lot of misunderstanding in discussion of Islamic Forex is that of short selling.
Many terms used in Forex derive from stock trading, as Forex trading in the modern sense was mostly unknown until about the year 2000. In fact, before the 1970s, the exchange rates between almost all major currencies were fixed.
In stock trading, “short selling” refers to the practice of trying to profit from the decline in value in stocks. As it is impossible to sell something that one does not own, stock traders would borrow shares that they wanted to sell short, sell them, and pay interest to the lender while hoping that the value would decrease. This riba element of course made the practice clearly haram. The borrower of the shares would then hopefully to be able to buy an equivalent number of shares to what they borrowed later, but at a cheaper price, repaying the loan and pocketing the difference as profit.
In Forex, “short selling” refers only to a making a trade where it is hoped the price of a currency pair or cross goes down. There is no essential difference between making a short or long trade in Forex, and there is no essential borrowing element required to make this transaction. We can therefore be clear that there is no problem per se with Forex short selling in Islam.
Sharia Law Investments and Halal Stocks
As we have moved into the area of stock trading, it is important to mention that there are important requirements of Islamic law in this area also. More and more Forex / CFD brokers are offering trading in individual stocks and shares, so Forex traders may find themselves trading stocks for the first time without really thoroughly considering the implications of these trades.
Investing in Sharia Law Investments
Many Muslims are careful to ensure that they comply with Islamic law in their long-term investments by only investing in funds which can legitimately label themselves as sharia law investments, especially if they are resident in countries with no Islamic legal framework. In most western countries, this can nowadays be achieved easily.
If a Forex / CFD broker offers trading in individual stocks or stock market indices, and the legal format is structured in a way that the legal ownership of the stock vests in the trader, these trades clearly do not comply with Islamic law if the stocks are non-sharia law investments.
However, in most cases, the trader never takes ownership of the shares, and is really only taking a position on whether the price of the shares rises or falls. Is this an acceptable loophole? Very few Islamic scholars would say yes.
It therefore seems clear that the key issue in Islamic law regarding the trading of stocks or shares is whether owning part of the company itself is haram. Fortunately, this can often be easy to determine by consulting approved Islamic listings of stocks and shares which are deemed to be halal stocks or haram stocks. Most Forex / CFD brokers offering trading in stocks and shares tend to offer trading in mostly the largest, most well-known publicly traded companies on the stock exchanges of wealthy developed countries. This means that if you want to trade in such well-known shares, it is usually very easy to determine whether the company is widely agreed to be haram or halal, as there are plenty of easily accessible Islamic assessments easily searchable online.
This leaves the case of lesser-known companies who may not have been assessed much, if at all, by Islamic authorities. Here, the trader may need to apply the laws concerning which stocks are halal themselves if the broker offers no help and there is nothing online.
What Factors Make a Stock Halal?
The factors which make a stock halal are clear in Islamic law:
- Investors may not be paid interest
- Investors must share in profits / losses incurred by the company
- The company must not conduct business or invest in a business which is unacceptable under Islamic law. For example, it would be forbidden to trade in the shares of a casino.
Is Trading Indices Halal?
Equity indices are representative baskets of all the shares trading on a particular stock market. For example, the FTSE 100 index is calculated based upon the prices of shares in the 100 largest publicly quoted companies in the U.K., weighted by market capitalization. This means that if the value of all the shares in company X are worth 10% of all the companies traded on the exchange, the fluctuations in its price will account for 10% of the calculation of the index’s value.
Many Forex / CFD brokers offer trading in equity indices. Therefore, the question as to whether trading such indices is halal is an important one.
It is clear that almost every major equity index consists of at least 30 shares, or more commonly 100 (as in the case of the FTSE 100 index). It can even go as high as 500, as in the case of the S&P 500 index.
What Makes Trading Indices Halal?
In order for buying or selling an index to be halal, we would have to know that every single company within that index would be halal as an individual share. This is unlikely to be the case, unless the index is from the stock market of an Islamic country which imposes Islamic law upon its stock market.
One answer for Muslims which has been provided by some financial services companies has been to create Islamic versions of certain stock indices, screening out those companies deemed to be haram, and building an Islamic index with the remaining companies. This is done not only with market indices, but of course also ETFs. There is a large number of Shariah-compliant ETFs and these can be another option for Muslims who want to be exposed to a broad range of shariah-compliant stocks.
There are a number of Sharia-compliant equity indices, but unfortunately, very few Forex / CFD brokers offer them for trading.
Fortunately, some Forex brokers do offer major equity indices from Islamic countries.
Is CFD Trading Halal?
CFDs (contracts for differences) are essentially derivative instruments, based upon the price of an underlying asset. Typically, trading CFDs involves an element of riba, although Islamic brokers offer them without the overnight interest payments or charges.
The Challenge with CFDs
The heart of the Islamic problem over CFDs lies more in the fact that the instrument is typically a leveraged derivative. Of course, no trader is required to use leverage in trading. The potential problem with CFDs lies in the fact that one does not directly own the underlying asset.
Many have, however, pointed out that if riba and leverage are removed, and the CFD is clearly and predictably representative of an Islamically permissible underlying asset, perhaps a CFD can be compliant with the meaning of Sharia law. Of course, the underlying asset would have to be halal for this case to be made convincingly. Remember that CFD is just legal wrapping, not really an asset class itself. A CFD based on the S&P 500 stock market index could not be halal in any case, because there are several stocks within the S&P 500 index representing companies whose business is clearly haram.
Is Forex Day Trading Halal?
There is no special reason why day trading Forex, meaning trades that are opened and closed on the same day, is any more halal or haram than day trading other assets. The question as to whether Forex trading is halal or haram is covered thoroughly throughout the rest of this article, so the issue at hand is really whether day trading is halal.
There are two issues which might make day trading haram compared to longer-term trading in Islam:
1. Due to its short time frame, it could be argued that day trading is more like gambling or speculation than investment when compared to longer-term trading such as position trading.
2. Day traders have lower rates of success than longer-term traders. This could be argued to make it more like gambling as the odds are against all but the most talented traders.
Pros & Cons of Halal Forex Trading
To trade Forex in a halal manner, it is necessary to open a halal Islamic Forex account. The defining feature of such an account is that instead of paying or charging overnight swap fees as is normal in other types of Forex trading accounts, there is no swap element. Typically, a higher spread and/or commission, or some other kind of trading fee, is charged to make up for the lost swap fee, which in the retail Forex industry always have an overall bias against the trader and in favour of the broker.
Although Islamic Forex trading accounts typically do offer access to leverage, it can be argued that Forex trading should be done without any leverage to be truly halal.
Once this is understood, it is quite easy to identify the pros and cons of halal Forex trading:
Pros
- Overnight swaps are slanted in favour of the broker, and rarely pay the trader. This means that what is effectively an extra fee can be avoided in halal Forex trading. However, it depends what mechanism is used by the broker to recoup this income as to exactly how much of a pro for the trader this really is.
- If no leverage is used, a Forex trader may make less profit, but is far less likely to “blow up” their account through catastrophic leveraged losses. Therefore, halal Forex trader can be said to be safer.
- If the Islamic account carries an extra fee regardless of trades taken, the infrequent trader may be being penalised financially.
- An Islamic account may promote a longer-term trading style, which for most traders will be more likely to bring success.
Cons
- Where opportunities do exist to be paid a positive overnight swap on a trade, a halal trader cannot benefit from them.
- If no leverage is used, the Forex trader may be safer but miss opportunities to profit from good trading opportunities with a judicious use of leverage.
Is Forex Legal in Muslim Countries?
There are approximately 50 countries in the world with Muslim-majority populations, so this is a complex question to answer in detail. The global Muslim population is about 25% of the world’s population.
The simple answer is that trading Forex is no more legal or illegal in Muslim countries overall than it is on average in the rest of the world, although there are Muslim countries which try to make Forex trading difficult or practically illegal for its citizens unless pursued through certain narrow channels, such as Turkey and Malaysia. On the other hand, there are Muslim countries that do not place obstacles in the way of their citizens wanting to open an offshore Forex trading account, if taxes are paid on profits, such as Saudi Arabia and Egypt.
It is fair to say that Muslim-majority countries on average probably have more outright bans on Forex trading than “western” countries, but “western” countries probably impose stricter regulation than what is seen in most Muslim-majority countries.
Conclusion
It should be stressed that though we’ve researched the issue of Islamic Forex and its validity within Islamic law at length, we are in no way attempting to provide religious guidance for readers of this article or their acquaintances. As evidenced in the research presented here, there are certainly many people who believe that in the right circumstances, Islamic Forex trading is permissible. However, there may be some that aren’t comfortable using these workarounds, and this is a completely valid approach as well. If you are interested in researching more on the issue or considering how each Forex broker implements their Islamic Forex system, we recommend that you evaluate our top Islamic Forex brokers and speak to their teams if you have any questions or concerns about how their practices relate to Islamic law. A solid and respectable Forex broker will have concrete answers and will make you feel at ease, not uncomfortable.
