Few social-cultural systems have impacted our society more than religion. The belief in a higher power has shaped the world through rituals, sermons and other practices but also through defining the fundamental guidelines of social behavior within the communities.
For religions like Islam, those guidelines include extensive references to finance, creating the concept of Islamic finance. Offering foreign exchange (forex) services to Muslim customers has to be in accordance with their beliefs through special Islamic accounts.
This article will cover the basics of Islamic forex accounts — how they work and what makes them different from ordinary ones.
Fundamentals of Halal Forex Trading
Islam is an old religion with complex guidelines, many of which offer in-depth principles for financial business.
Although some of them sound outdated by modern standards, their principles still apply. For example, a trade has to be immediately exchanged. This concept works through over-the-counter (OTC) trading. No interest is involved in any form, credited or debited. Halal forex trading has to be swap-free — without an interest fee for an overnight position.
Finally, forex trading has an advantage over other markets in terms of short-selling. Islam prohibits short selling — borrowing an asset while betting on its price decline. But currencies trade as a pair so selling a currency doesn’t have to involve borrowing any asset or interest element.
Is Forex Trading Halal or Haram?
Forex trading can be both halal or haram. It depends on the individual’s attitude toward it. According to Islamic law, something is considered forbidden or “haram” based on the guidelines of the Holy Quran.
The forex-related prohibited activities include charging interest and gambling. While Islamic forex accounts operate without charging interest, the gambling factor is partially up to the traders themselves.
Is their strategy sound? Are they operating with a specific purpose or randomly?
Islam doesn’t prohibit conducting regular business, which involves taking on risk, yet by removing the leverage factor, an Islamic forex broker removes the gambling element — making the trading halal.
Understanding How Islamic Forex Accounts Function
Islamic forex accounts have few key differences from regular accounts. Here are four things to keep in mind when trading through an Islamic forex account.
Islamic accounts are swap-free, meaning they don’t pay or earn swaps or interest on any trades. Instead, most brokers opt for a flat financing charge rate, also known as a commission, that depends on the currency pair. While popular pairs such as USD/JPY might have a low commission, exotic ones like EUR/ZAR might be 10 times more expensive. Eliminating Interest
Earning or charging interest or riba is one of the critical haram concepts in Islamic finance. In forex trading, interest is charged or accrued for trades that roll over into the next day. Islamic forex accounts don’t offer this, preventing some strategies based on that concept.
For example, borrowing the lower interest rate currency to fund a purchase of a higher interest rate currency is known as a carry. Yet, Muslim traders should not pursue it, nor should it work on Islamic forex accounts.
Limited Currency Pairs
Using an Islamic forex account might limit access to some exotic currency pairs. This is mainly because of the broker’s expenses associated with the significant interest rate differentials. Exotic currency pairs involve emerging markets that often have high-interest rates, such as Turkey or Thailand, and brokers cannot process those trades under halal guidelines.
This limitation doesn’t impact most traders who prefer to stick with the most popular currencies: the U.S. dollar (USD), the Euro (EUR), the Japanese yen (JPY), the British pound (GBP), the Canadian dollar (CAD), the Swiss franc (CHF), the Australian dollar (AUD) and the New Zealand dollar (NZD).
By offering leveraged trading through borrowed funds, brokers make a sizeable portion of their income by charging swap interest. Because charging interest is not allowed in Islamic finance, they have to find some other compensation to make it up by setting a wider spread.
This spread seldom makes a difference for long-term traders, but it makes short-term trading (scalping) much harder. Traders who execute tens of daily trades might have to adjust their approach as fees and spreads quickly add up, eating into the profits.
Religious Compliance Comes With Restrictions
Religion is essential to many people’s lives. Its influence stretches far beyond the spiritual element and sometimes deep into established business practices. Currency exchange is a fundamental part of international business, and the only way it works is through currency trading.
By collaborating with Islamic scholars, forex brokers found a way to offer their services in a halal way. While it limits access to some markets or prevents pursuing specific strategies, it is a small price to access one of the largest markets in the world.
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