Forex Trading and Muslim Sharia Law Overview
Forex, or foreign exchange, trading refers to the buying and/or selling of currencies in exchange for another. The forex market is the most heavily traded market in the world due to individuals, businesses, banks, and other countries’ participation in the exchange of currencies.
It is one of the markets that offers traders with ease of access in addition to it not requiring a substantial amount of capital to get started.
When trading forex, traders will encounter a variety of fees that they must evaluate and consider, ensuring that it is aligned with their trading plan. One of these fees is that of rollover fees, overnight, and/or swap fees.
When trading in forex, there are two different currencies involves and subsequently two different interest rates. When holding an overnight position, it means that the trader holds their current position open after the broker’s stated cut-off time at the end of the trading day.
With overnight fees, interest can either be earned or charged depending on the interest difference between the currencies in the forex pair that the trader holds open in their position. A swap occurs due to the overnight interest rates which is different for each of the currencies in the pair.
Swaps and Rollovers
A swap, or swap rate, refers to the overnight fee being paid or deducted from the trader’s account on an open position. Both swaps and rollovers are closely related, and they are frequently used interchangeably.
Rollovers are a crucial concept where forex trading is concerned and one that traders must familiarize themselves with, especially where more advanced strategies are concerned.
A rollover can simply be defined as the process involved with the delay in the settlement date of an open trading position. For traders who trade ‘spot’ forex, all trades settle two business days after the trade was opened as according to market convention.
The settlement date is also known as the value date and this is where rollovers come in. when traders roll over the position, they essentially extend the settlement period by one more business day.
This closes the existing position at the daily close rate and simultaneously re-enters a new opening rate on the next trading day, that extra business day mentioned above.
This incurs a rollover fee, and due to the nature of forex trading and the fact that traders do not have the intention to take physical delivery of the currency that they buy, they profit from fluctuations in the exchange rates.
It is for this reason that rollover has become a useful trading method when trading forex. When considering that forex trading is done through the borrowing of one country’s currency in order to buy another, traders either receive interest, or they have to pay interest.
At the end of every trading day, the trader who entered into a long position on a currency with high yield, relating to the currency that they borrowed, will receive a certain amount of interest, which is paid into their trading account.
The same is true when reversed, the trader must pay interest should the currency that they borrowed have a higher interest rate relative to the currency which they purchased.
Traders who want to avoid being subjected to such fees must ensure that they close all positions before the cut-off times at the end of the trading day.
The cost of the rollover is based on the interest rate which is differential of both currencies in the forex pair. For instance, the interest rate between the European Union (EU) and the United States of America (US) are 4.25% and 3.5% per annum, respectively.
Should the trader buy a position of 1.0 lot in EUR/USD, they will earn 4.25% on their Euros and they will borrow USD at a rate of 3.5% per year. Now, to understand how the concept applies, traders can look at the following scenarios:
- Should the trader have a long position, or they buy, and the base currency in the pair has a higher overnight interest rate than the quoted currency, traders will receive interest.
- Should the trader have a short position, or they sell, and the base currency in the pair has a higher overnight interest rate than the quoted currency, they will forfeit the difference.
- Should the trader have a long position and the base currency in the pair has a lower overnight interest rate than the quoted currency, they will forfeit the difference.
- Should the trader have a short position and the base currency in the pair has a lower overnight interest rate than the quoted currency, the trader will earn interest.
The Sharia Law, and Islamic Forex Accounts
The Sharia Law – Overview
The Sharia law, a religious law which forms part of the Islamic tradition, is derived from religious precepts associated with Islam.
The rulings of Sharia Law are specifically concerned with ethical standards along with legal norms with some areas which overlap with Western notions of law while others correspond more holistically with living life in accordance with the will of God.
What is the ruling where forex trading is concerned?
Where allowance of forex trading is concerned, it is quite considerably inconclusive to provide a definitive answer. Islamic authorities agree that there are certain halal conditions associated with the exchange of currencies but there are disputes regarding the exact conditions.
The saying on the subject matter, as according to Prophet Mohammed (peace be upon him) is as follows, “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, same for same, hand to hand. If the types are different, then sell however you like, so long as it is hand to hand.”
Sharia Law, also known as Shariah, or Shari’ah, is a religious Islamic law which governs both religious rituals in addition to day-to-day life and activities in Islam. When literally translated, Sharia means ‘the way’.
Finance which is considered compliant with Sharia is an area of modern finance which is progressively growing amongst numerous banks as well as investment houses. This is due to investors who work alongside the Middle East with the increases in oil prices.
Usury, which is the act of lending money at high rates of interest, unreasonably, is completely prohibited in Islam. This means that any type of deal or contract which is associated with an element of interest, or Riba, cannot be permitted, as according to Islamic law.
Forex trading and Sharia Law
Forex trading has been one of the most debated topics where Islamic jurisprudence is concerned. For the purpose of reaching a general consensus, numerous ordinances as well as fatwa’s, which are Islamic rulings issued by religious authorities of Islam which are universally recognized, have subsequently been issued on the matter.
The conditions that have, however, been specified, are as follows:
Interest, or Riba, is prohibited
The taking of interest is strictly forbidden where Islam is concerned and there is no place for any ‘grey’ areas where this is concerned. Thus, the exchange of forex which involves any usury, cannot be allowed.
Should traders be dealing with the same kind of currency, for instance euro to euro, the exchange must consist of equal amounts, or 1 euro for 1 euro.
Traders can therefore not trade the very same currency for varying values such as 1 euro for 3 euros or it would fall within the domain of Riba.
The trade, or the exchange, must occur in the same sitting in which the contract has been formulated
Traders may trade one type of currency for another, but it must be done in the same meeting as when the contract has been signed.
The trade, or the exchange, must be hand-to-hand, it must be immediate and there must not be a delay
The buying and selling of currencies in the forex market are permitted but the exchange must be done immediately, and any delays must be avoided. Should there be any delay, the transaction may fall into the umbrella of Riba and it is therefore prohibited.
The exchange of currencies may also happen telephonically or through the internet (through a broker) as long as the exchange results in the immediate transfer of funds from the account of the seller into that of the buyer, or should the buyer or their agent take immediate possession of a cheque payment.
Islam recognizes that nearly all adults have a desire to improve their financial positions in addition to realizing that life involves a predominant level of uncertainty.
It is also noteworthy that the Islamic law strictly forbids gambling, even merely as a form of recreation or entertainment. Forex trading has been compared with gambling in numerous instances, but there is an element that greatly sets it apart.
The method of speculation is what makes the difference especially where fundamental analysis is concerned but technical analysis is not.
Speculation according to technical analysis can be seen as betting on the bets of others which translates to reliance on the behaviour of the masses to influence the traders speculation, which is subsequently the essence of gambling and which is strictly forbidden by the Islamic law.
However, this argument is greatly criticized as spurious where the market realities are concerned.
Should a trader believe that the euro will rise against the US Dollar due to economic fundamentals which are bound to executing the trade immediately, will the trader be forbidden to take action in timing the entry of their trade to a psychologically opportune moment?
It is for this reason that traders are urged to conduct thorough research and to decide whether Islamic, or halal forex, is suited for them.
Traders may also seek more information to gain a further and clearer understanding of the boundaries which may be more razor thin and unclear between various aspects of Sharia law and market conditions as they present themselves.
How do Forex Brokers accommodate Muslim Traders?
Forex brokers have, for long time, reflected the market practice involved with paying, or charging, the trader with interest which is differential to the two currencies in a forex pair when the position remains open overnight.
However, when considering that the Sharia law has become part of the financial world and in order to accommodate the followers thereof, many institutions have had to adapt to these laws, there have been a great number of forex brokers who have had to confirm to the Sharia law to provide what is called ‘halal forex trading’.
It is for this reason that there are so many forex brokers who offer Islamic accounts, also known as Swap-free accounts, which are accounts where interest is not charged when overnight positions are held.
To ensure legitimacy, there is a Sharia Supervisory Board, or SSB, which is tasked with ensuring that financial transactions are Sharia compliant.
Financial firms, such as forex brokers, who carry the SSB seal of approval are therefore certified to have financial products which are halal as they comply with the ethical principles involved with Islamic finance.
Muslim traders who come across such brokers therefore have the assurance that transactions do not involve underhanded interest and they do not carry any excessive risks or uncertainties.
Aspects and features of forex Islamic Accounts
There are numerous forex brokers who either offer Islamic Accounts as a standalone account in addition to other trading accounts, or forex brokers offer the Islamic Account as an option.
When offered as an option, Muslim traders can register for a live trading account and after their account has been approved, they have the option to convert their live trading account to that of an Islamic Account.
These Islamic Accounts are also known as Swap-free accounts, and they differ in several ways from regular forex accounts. These accounts do not pay or receive interest rates and they are based on Islamic finance, which calls for the immediate transfer of currencies in addition to the transaction costs.
There are, however, forex brokers who may either increase commissions on Islamic Accounts, or they may charge wider spreads or additional administration fees to make up for costs lost in the absence of interest, whereas others may not charge such fees.
These conditions differ between brokers and it is a crucial factor that traders must explore and verify with their broker of choice before they register for a live trading account.
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