Is forex trading ‘halal’? The simple answer to this question is ‘Yes’, forex trading is halal, but there are certain prerequisites that traders of Islamic belief need to fulfil. Today, we will shed light on all the things that Muslim trading enthusiasts need to know before they begin their voyage to becoming forex traders. In order to make forex trading available for Muslim traders, many forex brokers started offering Islamic trading accounts, which are compliant with Islamic teachings and are somewhat different from regular accounts in several aspects.
While there are a handful of differences between a normal and an Islamic account, the most noteworthy of them all is the absence of interest, which means, the trader won’t pay or receive any interest. To further elaborate on this, a trader having an Islamic account won’t pay any swap charges for keeping the positions open for more than 24 hours. For this reason, an Islamic account is also called a swap free account. As a result, swing and position traders can save a considerable amount of money, which they would have otherwise paid in the form of a swap fee.
Swap fees make up for a huge chunk of the revenues of forex brokers but they compensate for the losses by offering wider spreads and a flat commission, which is usually higher than the usual. But, there are certain forex brokers that offer an Islamic fx account without increasing the spreads or commission.
A swap-free account eliminates the possibility of carry trades, plus it allows traders to keep their positions open for days without worrying about expenses.
Islamic/Forex Swap Free Accounts – In Detail
Islamic trading accounts are similar to regular accounts in a number of aspects. However, the former is a type of account designed to be compliant with the teachings of Islam on forex trading. The differences between the two types of accounts consist of the following:
- There are no swaps paid or received for keeping the positions open overnight.
- Islamic trading accounts usually have wider spreads
- Some brokers don’t allow traders using Islamic trading accounts to access emerging market currencies
- Trading commodities like gold and silver on Islamic trading accounts are often backed by physical gold.
Let us now delve into the details of each of these differences and their effects on forex trading:
Removing interest
Many Muslims who wish to trade currencies don’t know if it is halal or haram. These words might be unknown to many, but in Islam, these are of great significance.
Haram is an Arabic word that means ‘forbidden’, so anything haram is sinful in Islam and may have repercussions. In order to make forex trading ‘halal’, which means permissible, brokerage companies had to eliminate any type of interest charged in forex trading, as there is a strong prohibition of paying or receiving interest in Islam.
Traders using regular trading accounts will either pay or receive interest for keeping the positions open overnight, also known as a swap or rollover fee. Whether a trader pays or receives the swap depends upon the relative bank interest rates of the two currencies involved in the currency pair. Moreover, brokers also add a certain percentage of commission on the interest rate differentials.
In Islamic accounts, all these dynamics are out of the picture, hence making it easier for traders to keep positions open overnight without worrying about rollover charges. There are several benefits of trading in a swap-free account. Let’s take the Japanese Yen and Swiss Franc as an example, these two currencies are positioned to make gains against some of their counterparts. The assumption is premised upon certain technical indicators or due to low inflation rates of the currencies. The purchasing power parity indicator favours their appreciation because, in the long term, currencies with low inflation rates would appreciate better compared to those with higher CPI rates.
However, having a position for JPY and CHF can cause issues with a regular trading account because the interest rate differentials will lead to high swap charges. This is the reason that trading low-yielding currencies are a big no-no with regular trading accounts. This might not be a problem for day traders and scalpers since they won’t be leaving the position open overnight, thus avoiding rollover charges. On the other hand, Islamic account holders can keep the position for as long as they like, since there won’t be any swap charges to pay.
Downsides of Forex Swap Free Account
Traders having Islamic forex trading accounts should also know that the possibility of carry traders is also eliminated due to the simple reason that this forex strategy involves borrowing a low-yielding currency to buy high-yielding currencies and receive money in the form of interest rate differentials. But, since there are no swap charges, carry trading strategies would be of no use.
Wider Spreads
Forex brokers earn from spreads, commissions, and swap charges, and when one of these sources shuts down, they compensate for it by raising the others. So, traders having Islamic accounts would find spreads higher compared to standard trading accounts. As a result, scalping goes out of the question because this strategy is based on profiting from small market movements, so when the spreads are higher, overall gains will dwindle.
Limited Currency Pairs To Trade
Another downside to Islamic forex accounts is that traders having such accounts might not be able to trade exotic currency pairs, which include the South African Rand (ZAR), Russian Ruble (RUB), Mexican Peso (MXN), and Turkish Lira (TRY), etc. The reason why brokers don’t allow traders with Islamic accounts to trade emerging market currencies is that they have higher central bank interest rates. Borrowing funds in these currencies can be an expensive affair in nominal interest rate terms. It won’t be possible for forex brokers to offset the costs by charging traders having Islamic accounts an interest, as that would be ‘haram’.
Similarly, forex brokers don’t allow market participants to exchange exotic pairs with Islamic trading accounts, which helps them save decent money linked with large interest rate differentials between major and exotic currencies.
The best pairs for traders with Islamic accounts to trade include:
- USD
- EUR
- GBP
- JPY
- CAD
- AUD
- NZD
- CHF
These pairs are more predictable and less volatile compared to emerging market currencies, which makes them great for finding solid trading opportunities.
Conclusion
Islamic trading accounts have a fair amount of advantages with a few disadvantages, but traders with Islamic beliefs must opt for an Islamic account if they wish to trade currencies. Traders can choose to swing trade or open long positions to benefit the most from forex swap-free accounts. So, sign up for an Islamic account and start trading in the ‘halal’ way.
This article was originally on 3 February 2023.
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