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Disclaimer: Margin trading is not considered permissible as per Islamic finance principles. This article is for informational purposes only and not a recommendation or endorsement of margin trading.
If you are an avid trader, you have likely been intrigued by the concept of margin in trading. It is a tool that allows traders to amplify their profits by borrowing money to invest in the market. In this comprehensive guide, we will delve into the depths of margin trading.
Margin trading is essentially using borrowed funds from a broker to trade larger positions than what you could with your own capital. This leverage enables traders to potentially earn higher returns on their investments. However, it is important to note that margin trading also comes with its fair share of risks.
Margin Trading Is Not Halal
Margin trading as currently practiced in various stock markets is impermissible from a Shariah perspective. Trading on margin means borrowing money from a brokerage firm in order to carry out trades. When trading on margin, investors first deposit cash that serves as collateral for the loan and then pay ongoing interest payments on the money they borrow. This loan increases the buying power of investors, allowing them to buy a larger quantity of securities. The securities purchased automatically serve as collateral for the margin loan. Typically, when an investor takes out a margin loan from a broker, the borrowed funds must be used to trade within that broker’s platform. This restriction helps the broker manage the risk associated with the loan and maintain control over the collateral. Additionally, by keeping the trading within their platforms, brokers can benefit from additional fees and commissions. Therefore, an investor generally cannot use the borrowed money to trade on other platforms.
Brokers charge interest on margin loans and restrict borrowers to trading using their platforms to benefit from the margin loans. This is inimical to the Islamic precepts, which prohibit riba and benefiting from loans. Maulana Mohammed Aneesur Rahman notes the following:
“Margin trading on conventional markets and the use of collateral in interest-based transactions is not permitted. Both are not Shariah compliant.”
Contemporary Muslim scholars and Islamic finance experts are unanimous on the impermissibility of margin trading. The OIC Fiqh Academy in its 18th session held in Makkah on margin trading stated that margin trading is impermissible as it entails several Shariah concerns.
Read: Simple Answer about Options Trading: Halal or Haram?
Understanding the Concept of Leverage
Leverage is the cornerstone of margin trading. It allows traders to control a larger position in the market with a smaller amount of capital. For example, with a leverage ratio of 10:1, you can control a position worth £10,000 with just £1,000 of your own capital. While leverage can magnify profits, it can also amplify losses.
The Conventional Benefits and Risks of Trading on Margin
Trading on margin might offer several benefits from conventional point of view. It provides traders with the opportunity to enter larger positions, potentially increasing their profits. Additionally, margin trading allows for more diversification, as traders can allocate their capital across multiple trades.
However, trading on margin is not without its risks. The primary risk is the potential for losses to exceed the initial investment. If a trade goes against you, the borrowed funds can quickly deplete your account balance.
Margin Requirements and Calculations
Margin requirements are set by the broker and vary depending on the asset being traded. They are typically expressed as a percentage of the total position size. For example, if the margin requirement is 10% and you want to trade a position worth £10,000, you would need to have £1,000 of your own capital.
To calculate the margin required for a trade in monetary terms, the following formula can be used:
Margin Requirement = (Position Size * Price) * Margin Rate
Different Types of Margin Accounts
There are different types of margin accounts available to traders, each with its own specific requirements and features. The two most common types of margin accounts are:
- Reg-T Margin Account: This is the standard margin account that allows traders to leverage their positions up to a certain limit set by the broker. It requires a minimum initial deposit and has specific maintenance margin requirements.
- Portfolio Margin Account: This type of account is available to experienced traders who meet certain criteria set by the broker. It offers more flexibility in terms of margin requirements, as they are calculated based on the overall risk of the trader’s portfolio.
Margin Calls and Forced Liquidation
A margin call occurs when the account’s equity falls below the required margin level. When this happens, the broker will issue a margin call and require the trader to deposit additional funds to bring the account’s equity back up to the required level.
If a margin call is not met, the broker has the right to liquidate the trader’s positions to cover the losses. This is known as forced liquidation.
Must Read: 6 Tips on How to Build Portfolio Diversification
Also Read: Learning How to Trade Stocks: A Complete Beginner’s Guide
Wrapping Up
As with any trading strategy, thorough research and a clear understanding of margin requirements, leverage, and the specific features of different margin accounts are essential.
For Muslim traders, it is important to note that margin trading is not halal due to its reliance on interest-based transactions, which are not compliant with Islamic financial principles.
Disclaimer: Important information