What Muslims Should Know About Short Selling

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 is short selling?

Firstly, let’s get to know its definition first. 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 it Halal?

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.

In conclusion, short selling is problematic in Islam since it contains unlawful procedures in its activity.

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