What Muslims Should Know About Short Selling

Before we do trading, we must make sure whether or not the trading procedure is halal. There are a lot of trading terms that confuse a beginner, one of them is short selling. It is popular among traders because it offers a big profit, but an infinite amount of losses can happen due to margin calls.

So, in this article, we will talk about short selling and if you are curious enough about whether short selling is allowed or not, then this article is for you.

What are Islamic Finance Principles

First, let’s get our basics in place. Islamic finance is built on principles intended to ensure fairness, transparency, and ethical conduct in business and financial transactions. These principles are derived from the Quran and the Hadith, and they guide all economic activities according to Shariah (Islamic law). Here are the core principles relevant to our discussion:

• Riba (Interest): Riba is strictly prohibited in Islam. It refers to the premium that must be paid by the borrower to the lender along with the principal amount, as a condition for the loan or for an extension in its maturity. This principle is meant to ensure fairness and prevent exploitation.
• Gharar (Uncertainty): Gharar is another significant concept in Islamic finance, referring to excessive ambiguity and uncertainty in the terms of a contract. Islamic finance requires all contractual terms to be clear and certain to avoid disputes and unfair advantages.
• Maysir (Gambling): Maysir means gambling and is prohibited because it involves earning money by chance instead of productive effort, which can lead to societal harm and personal ruin.

What is Short Selling?

Short selling is an agreement where you sell a stock at a higher price and buy it at a lower price. It is almost similar to the condition where we buy a stock at a lower price and sell it at a higher price to gain profit. But what makes them different is, in short selling, we sell before we buy.

To make it clear, let’s see this example:

1. The price of ABC stock is $200 per share, and you believe it will fall to $150 in the near future. Then you would like to profit from your prediction. So you ask your broker to lend you the ABC share.
2. You borrow the share from the broker, but you must return the share to him later. 
3. Then, you take that borrowed shares and sell it for $200 per share at the current market price.
4. You can repurchase the share you have sold if your prediction is correct and the price falls to $150/share. Then, you have to pay back the broker the share as you promised at the beginning. The difference between the price you paid when you sold them and the amount you paid to get them again is your profit.
5. If your prediction is incorrect and the price rises to $250/share, then you have to return the broker the share with a price of $250. So, it means you incur a $50/share loss.

Is Short Selling Halal?

As mentioned previosuly, Islam prohibits riba, gharar, maysir, and unlawful activities. When it comes to short selling, apparently, there are several things related to prohibited things.

Firstly, if the broker charges a fee when the trader lends the share, it is similar to riba. Riba is an additional benefit that the lender gains which can burden the borrower. The only loan that is allowed in Islam is qardh-al-hasan (charity) that has no burden of interest for the borrower.

Secondly, it contains gharar (uncertainty). Even if the broker does not charge the trader, it is still not permissible to sell something we do not own. Remember the previous example? We borrow some shares from the broker then we sell the share without fully owning them. If we want to fully own the share, we have to buy first.

Last but not least, it is similar to maysir (gambling). If we buy a stock and fully own them, it means we also bear its full risk. Besides, we also doing a valuable activity because we own part of a company. It is different from short-selling where the broker bears the risk and we bear an unlimited risk. If our prediction is false, we are susceptible to gain massive losses.

Alternatives to Short Selling in Islamic Finance

Muslim investors seeking to adhere to Shariah principles have several alternatives:

• Equity Investments: Investing directly in the shares of companies that comply with Islamic principles. This involves thorough research to ensure that the business activities are halal.
• Sukuk (Islamic Bonds): Sukuk are financial certificates that provide investors with a share in the ownership of an asset. Returns are generated from the underlying asset rather than from interest.
• Islamic Funds: These are mutual funds structured in compliance with Islamic laws. They exclude companies involved in prohibited activities like alcohol, gambling, and interest-based finance.

Practical Guidance for Muslim Investors

To ensure that investment activities are halal, Muslim investors are advised to:

1. Consult Knowledgeable Experts: Seek advice from financial advisors knowledgeable about both Islamic finance and modern investment practices.
2. Use Shariah-Compliant Tools: Employ tools like Musaffa halal stock screener to identify permissible investments.
3. Invest in Islamic Indices: Consider indices like the S&P 500 Shariah, which are specifically screened for Shariah compliance.

Bottom Line

To wrap up, while short selling might offer significant profit opportunities, its alignment with Islamic financial principles is highly contentious. Muslim investors are encouraged to explore and utilize Shariah-compliant investment avenues that not only adhere to Islamic ethics but also contribute positively to societal welfare. This approach not only ensures compliance with religious doctrines but also promotes a fair and equitable economic system.

FAQ on Short Selling in Islamic Finance

1. Is short selling allowed in Islam?

Short selling is generally considered not permissible in Islam because it involves selling what one does not own, which introduces elements of uncertainty (gharar) and risk that are inconsistent with Islamic financial principles.

2. Is short selling forex halal or haram?

Short selling in forex, much like in stock trading, is viewed as haram in Islam. The practice typically involves significant risk and speculation, which contravene the principles of Shariah law that forbid excessive uncertainty and gambling (maysir).

3. Is short selling Shariah compliant?

Short selling is not Shariah compliant due to the inherent risks, the speculative nature of the practice, and the potential for it to involve interest (riba), which is prohibited in Islam.

4. Is short-term trading haram in Islam?

Short-term trading is often considered haram if it involves excessive speculation or transactions that include elements of uncertainty and gambling. However, if conducted within the ethical boundaries set by Islamic finance, it can be permissible.

5. Is short and long haram?

In financial contexts, taking “short” positions is generally considered haram due to the reasons mentioned above. Taking “long” positions, where an investor buys stocks to hold, is permissible if the stocks are Shariah-compliant.

6. Is Shorting haram Shia?

In Shia Islam, similar to Sunni viewpoints, shorting is generally considered haram because it involves significant gharar and can include other prohibited elements like gambling and interest.

7. Which trading is halal in Islam?

Trading is considered halal in Islam if it avoids haram elements such as interest, excessive uncertainty, and investing in businesses that deal with alcohol, gambling, or pork. Investments should be made in companies that are beneficial to society and operate in line with Islamic ethical standards.

8. Is short trading halal in Islamqa?

According to various Islamic finance resources like Islamqa, short trading is not halal as it involves selling borrowed items that the seller does not own, introducing unacceptable levels of risk and uncertainty, which are prohibited in Islam.

9. What is the rule for short selling?

Generally, the rule for short selling in conventional finance is that an investor borrows shares to sell them at a high price with the hope of buying them back cheaper in the future. However, this practice is not compliant with Islamic finance rules due to the risks and ethical concerns it raises.

10. Which country banned short selling?

Countries like Spain, Italy, South Korea, and others have temporarily banned short selling at various times, typically during periods of significant financial volatility, to stabilize markets and prevent excessive speculation.

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