Financial Market Trading and Islamic Finance - dummies

By Consumer Dummies

If you’re thinking about investing in Islamic finance or an Islamic nation or company, know that some types of financial market activity, such as margin trading, day trading, options, and futures, are considered gray areas in Islamic law. The majority of Islamic scholars believe that sharia law prohibits these transactions because the activities involve interest, speculation, and excessive risk without market knowledge. Here’s a quick rundown about each type of activity and how it fails to follow sharia law:

  • Margin trading: In margin trading, you buy stocks by getting a loan from your broker. (The broker charges you interest on the loan.) In addition to the interest itself being problematic, the risk involved with this type of activity is extremely high. If you invest the loaned money in a stock that loses value, you may find yourself unable to pay back the money you’ve borrowed and the interest you owe your broker for providing the loan.

  • Day trading: From the Islamic perspective, day trading in the stock market isn’t actually an investment activity because the person doing it isn’t concerned about the underlying product or economic activity being supported. Instead, day trading is just a transaction based on observing the market price fluctuations on a given day. Of course, it involves a substantial amount of risk because the day trader is essentially gambling that the price of a certain stock is going to rise or fall on a given day. This makes day trading a no-no from a sharia perspective.

  • Options: A financial contract is sold by the option writer to another party, giving the second party the right to buy or sell a specific financial asset at a fixed price on or before a certain date. In other words, the second party is given the chance to buy or sell without an obligation to buy or sell.

    In theory, options are used to reduce investment risk. However, they themselves are highly risky and speculative in nature. The majority of Islamic scholars agree that options have features of speculation and gambling. In addition, the investor (second party) doesn’t intend to hold the asset (which is generally considered crucial for an investment to be sharia-compliant). Based on these characteristics, most Islamic scholars believe that options are prohibited investments.

  • Futures: A financial contract to buy or sell financial assets or commodities on a future date is traded on futures exchanges. The basic difference between futures and options is this: In a futures contract, both the buyer and seller are obliged to perform the contract; an options contract is optional and can be allowed to simply expire, unused.