Leveraged trading and the Islamic position on it
What is leverage?
Leverage is a financial mechanism that allows a trader to control a larger amount of capital than they have available by borrowing from a broker. For example, if a trader uses a leverage of 1:10, every $1 of capital allows them to trade $10 worth of capital.
The main purpose of leverage is to increase the trader’s purchasing power, which increases the chances of making profits from small market movements. However, it also increases the risks, as it can lead to large losses if the market moves against the trader’s expectations.
Leveraged Trading Risks
1. Major losses:
Leverage magnifies losses as much as it magnifies profits. A trader may find himself losing all of his capital quickly if the market moves against his expectations.
2. Liquidation (Margin Call):
If losses exceed a certain level, the broker automatically liquidates the open position, which means losing the remaining capital.
3. Risk addiction:
Leveraged trading encourages risky decisions due to the lure of quick profits, which can lead to emotional and ill-considered trading.
4. Not owning real assets:
In some cases, such as contracts for difference (CFDs), the trader does not own the financial asset, but rather deals with contracts that represent the price only, which increases the risk.
5. High volatility:
Leverage makes trading more sensitive to small fluctuations, making it more difficult to manage risk.
Islam's position on leveraged trading
Islam places great importance on ensuring the integrity and fairness of financial transactions, and there are a number of aspects that make leverage unacceptable in many cases:
1. Usury (interest):
Leverage often involves interest-bearing loans, where the broker charges a financing fee on the amount borrowed. Usury is forbidden in Islam, so any transaction involving interest is impermissible.
2. Gharar (excessive risk):
Leveraged trading carries a high level of uncertainty, as the outcome is largely unknown, and a trader may lose all of his money due to small fluctuations. Islam forbids transactions that involve clear uncertainty.
3. Lack of real ownership:
In some forms of leveraged trading, such as contracts for difference (CFDs), the trader does not own the underlying asset they are trading, which is not permissible in Islam because transactions in Islam must be made on real assets.
4. Trading as gambling:
When leverage is used, trading often turns into a type of gambling due to the heavy reliance on luck rather than thoughtful analysis, and gambling is forbidden in Sharia.
Trading without leverage: the legitimate solution
To avoid the legal caveats associated with leverage, a Muslim can trade in a manner that is compatible with Sharia law:
1. Trading using personal capital only:
Avoid borrowing from a broker or using any tools that multiply capital.
2. Choosing Islamic accounts:
Some brokers offer interest-free accounts, but you should check that they are free of any other fees that may be considered interest-based.
3. Trading on real assets:
Investing in cryptocurrencies or stocks directly and owning the physical or digital asset rather than virtual contracts.
4. Manage risks wisely:
Investing in amounts that you can afford to lose, and avoiding reckless adventure.
Leverage may seem like an attractive tool for making quick profits, but it carries significant risks and contradicts Islamic values and principles in many cases. Therefore, it is advisable to stay away from it as a Muslim and look for investment methods that comply with Sharia, ensure integrity and justice, and protect capital from significant risks. Adhering to Sharia controls in financial transactions is not only a religious duty, but also a way to protect yourself and your money from unforeseen losses.