Is Forex Trading Allowed in Islam?
Sharia law states that only physical trading is permissible and that traders are not allowed to profit from interest rate differentials. This means that Carry forex trading is not allowed in Islam, neither is speculative trading in the form of gambling. There are many grey areas around these restrictions, nonetheless, Muslims are allowed to do spot forex trading for the purpose of hedging business risks, and for speculative market objectives which are also meant to hedge market risk, which if not implemented it will allow someone else to profit at their expense.
Generally Muslims are not allowed to do Carry forex trading, to trade forward and futures markets, or anything to do with profiting from interest rates or transactions which have to do with the future. Transactions must be spot type, and in a broader sense must serve a good purpose.
It is possible to use Islamic forex brokers which strongly comply with Sharia law. The interest rate issue has been solved, there are already brokers, even non Islamic brokers which do not pay or charge overnight interest rate on trades held, this is offset by larger margin requirements or possibly higher commission charges. But there are brokers today which actually require larger margins to allow you to trade, charge normal, low commissions, and no interest rate credits or charges are applied. This is often favored even by non Muslim forex traders.
The Big Picture
Things are not simple when it comes to world finance, and many people, Muslims and non Muslims debate various issues regarding the benefits and the negative effects that market speculators bring to the real economies of various countries. These speculators have made markets much more liquid, resulting in more stable commodity and currency prices, but are also blamed for the poverty that exists in heavily indebted countries, where the local currency may have fallen too much. And Sharia law is about doing the right thing, and prohibits making a profit at the expense of the poor, even if it is against open market principles. That’s why Muslim traders want to act morally, in every trade and investment they make.
The problem arises when various small businesses in Muslim countries, such as import-export businesses are faced with adverse forex rates, in this case Muslims are allowed to offset forex risk and market adversity. In other cases, such as when a Muslim country has borrowed money from the IMF, it pays back the debt, and with interest. So the citizens of that country feel the effects of interest charges. The IMF and other lending organizations will either charge interest, or they will devalue that country’s currency, which is another way for paying off its national debt.
These are complicated cases, and Muslim traders and business owners should seek the specific advice of Islamic scholars, on how forex trading can be used in such cases to offset the negative effects coming from the outside market, while not breaching Sharia law. And there are ways to do it.
Where Investment Banks Stand
There is a myth that investment banks make a lot of money in the forex market, without taking risks, that is absolutely not true! Investment banks, no matter how big they are, do take the same risks as other traders take. They are only slightly more wiser than most forex traders and often not wiser than individual private, more experienced traders. And when a risk event hits them, they can fail and go bankrupt just a fast as a small retail trader can lose all their money.
We have seen examples of Barings Bank, Long Term Capital Management, which went bust trading the financial markets, as well as the massive losing trades of other large banks that are still around today. So the markets are definitely not forgiving of mistakes and bad guesses, anyone can lose money. It’s just that most of these banks have different views on global finance and morality, compared to Sharia law. There are grey areas, with issues that have not been fully decided as being legal or not legal, by Sharia law, but on the big picture Sharia law prohibits profiting out of the misery of other problems, while it allows you to profit when your investment will help create something physical in the end, something that will benefit society and mankind.
So in that regard, today’s non Islamic investment banks, fall somewhere in between, they don’t fully obey Sharia law, but they are not in complete breach of it either. They do all kinds of investments, both beneficial and damaging to some local economies. For example, they provide liquidity, which is good, all liquidity from speculators makes markets smoother, and food commodity prices are not allowed, by the market itself, to skyrocket, this makes these commodities more affordable around the world, while also providing an incentive for more people to invest in the production of these commodities. One bad thing speculators can do, is accelerate the decline of a local currency, profiting in the process, and making life even more miserable for the people of that country. And speculators are simply the number of people, small traders, big traders, and banks, which take part in those trades. The trades are still risky for these traders, as the market could go either way, but when they are right they do make money at someone else’s expense, and when that someone else is already poor, Sharia law sees the injustice and wants to prevent it from happening. Other religions also have similar views, though there’s no actual law to discourage and prevent traders from specific types of forex trades.
What Muslim Forex Traders Should Do
Muslim traders around the world are allowed to trade spot forex, for the purpose of making a direct profit or for hedging against a loss. All trades must be related to some physical transaction which suffers as the result of outside market forces. But in any case no Carry trades are allowed. Muslims do physical transactions and business deals, which may suffer because of the change in the US dollar for example, in such cases they are allowed to protect themselves against such risks, through the forex market. Forex trading is fully justified in such cases, because it may even help stop a small business from going bankrupt and having to fire its workers. It is cases such as these where forex trading is not only allowed, but it is the moral thing to do. Sharia law is still very relevant today, one just has to consult an Islamic scholar to clear the grey areas, and get more problem-specific answers. Why specifically you need to trade forex, and what your goals really are.
Offsetting Market Risk through Forex Trading
In many cases around the world, citizens are heavily burdened when their domestic currency is devalued. Such as Venezuela’s currency recently was, this makes it impossible for farmers and manufacturers to sustain their businesses, because the raw materials they import have become way too expensive. You would think that a lower domestic currency would make things better, by making exports more competitive, and it actually can happen. But all imported products can become way more expensive than people can afford to pay. And this can cripple the entire economy.
In such cases, Sharia law allows you to implement various economic plans, such as the use of a different currency, or a physical currency such as gold, or other non physical currencies that are backed by gold. Investors and small businesses can in such cases, save their businesses and stop losing their hard earned money. As in the case of Venezuela, there are things people and small business can do, which are fully compatible with Islamic finance, to help rebuild their economy, reduce poverty and to reward foreign investors in the end. It is perfectly moral to profit out of Venezuela but only after your investment helps the people of Venezuela get out of poverty. And even though in Sharia law there’s no interest involved, there are other forms of rewards, which are basically financial rewards, but without the slave-master mentality that interest-bound investments are associated with.
Muslim traders are allowed to use forex in ways not related to interest rates, to make a profit, in order to offset a loss elsewhere. They can trade market volatility on a currency pair, they can trade commodities. But it has to be on the spot market. In other cases, Muslim traders and investors in an oil exporting country, can offset the loss of national income, when crude oil prices fall and keep in falling, by going long USDCAD, or by making direct trades on crude oil that are compatible with Islamic law. There’s nothing immoral about protecting your income. Because if you don’t protect it, then someone else will unfairly benefit at your expense, and at poor people’s expense.
Immoral finance practices are blamed not only by Islamic scholars, but also by other groups, of non Muslim people, who simply see the injustice. That’s why even in non Islamic countries there are some rules which help write off debts of people who have incurred too much debt because of interest rate charges, or rules that limit the amount of interest a bank can gain on a loan. Sharia law goes further, by arguing that you should also have financial goals which should end up benefiting society. And this is a requirement in other religions also, though in a less rigorous way.
The forex market today is neither evil nor good, it can be both, and profits made from it can have different kinds of impacts on the world. All traders, and especially Muslim traders should know that there’s a place for them in the forex market, this market is part of all people’s lives, and it matters, because it affects the cost of an investment, the profitability of a family business, and how import – export is done. Forex affects so many things and helps facilitate and smooth out trading of physical goods, around the world.
The Carry trade strategy is the main strategy that is not allowed in Islamic forex trading, and even that comes with massive risks, risks that even investment banks cannot evaluate. Critics will argue that this strategy should be allowed, even for Muslims, in cases where their own country pays interest rates to some foreign lender, or that the national currency may fall as a result of that debt. Sharia law is against this strategy and against using forex brokers that work with interest rates. Nonetheless, even Muslim traders in heavily indebted countries, can still make Sharia-compatible forex trades that will offset the effects of such national debts, at a personal level. Muslim forex traders are allowed to trade the volatility of the spot forex market, and from that alone, one can offset the negative effects the global markets have on them. Market liquidity is there, it’s the same pool liquidity that contains all effects, both bad and good.
In commodity markets such as gold, crude oil or grains, when priced in USD, the impact of the USD is directly seen in the commodity prices. So if one trades for example gold, even physical gold, they are already, also, a forex trader who trades the USD. So the forex market can be used to offset risks in these commodities and to stabilize a business which depends on the price of these commodities. You can find your way to morality and justified forex trading from these trades, and then learn more about Sharia law and how it specifically may or may not permit your new forex trading strategy. In most cases it will permit it.