Leverage has become the cornerstone of modern retail trading, and its ubiquity has made it indispensable. Many markets, such as futures, are nearly impossible to trade without leverage because exchanges automatically build leverage into them, and others require leverage for practical reasons because the absolute price movements are small.
So, leverage is here to stay. However, leverage is not always halal for Islamic traders, depending on how brokers apply it. This article explores leverage from an Islamic or Shariah perspective to see when it can be halal (compliant with the Islamic legal principles of Sharia law) versus haram (non-compliant with Sharia law).
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Leverage and Margin Trading Basics
Before getting started, let's get a clear definition of the terms.
Leverage, or margin trading: The trading community uses the terms “margin trading” and “leverage trading” interchangeably to mean the same thing.
Leverage means using less capital to control a larger asset value. For example, if I wanted to enter a trade to purchase or go long $100,000 worth of gold with a 20:1 leveraged contract, I would only need a twentieth of the notional value, i.e., $5,000. The “20:1” is known as the “leverage ratio.”
Margin is the amount I need for the leveraged trade. In the above example, with a $100,000 gold contract and 20:1 leverage, my margin is $5,000.
The broker lends me the difference between my margin and the contract's notional value. Taking the same gold example, for $100,000 worth of gold at 20:1 leverage, the broker is effectively lending me $95,000 to finance the trade.
Derivatives, such as futures contracts, Spot Forex, and CFDs all trade on leverage. Nearly all retail trading uses leverage. An unregulated broker can offer unlimited leverage, whereas a regulated high-leverage forex broker will limit leverage to 1:500.
Leverage magnifies both profits and losses. If the price of gold went up 5% on a 20:1 leveraged contract, my profit relative to the margin is 100%. However, if the price dropped by 5%, I lose my entire margin. In practice, the broker would require more margin for me (a “margin call”), or they could close my trade automatically if I don’t meet their margin call.
A Shariah Law Perspective
Shariah Finance is a broad topic that instructs Muslims on methods for conducting financial transactions that follow Islamic principles. Several underlying Shariah concepts directly impact how Muslims should consider trading. Let’s look at them:
- Money is a medium of exchange, as opposed to an asset. This is one of the most central Shariah financial principles, and many other rules derive from it. The core of this rule is that since money is a medium of exchange, there should be an underlying exchange of goods or services for every financial transaction.
- Islam prohibits paying or receiving interest (also known as Riba in Islam). This principle stems from the notion that money is a medium of exchange. Interest is a charge on money itself without an underlying exchange of goods or services—in other words, interest treats money like an asset, so Islam prohibits it.
- Excessive uncertainty or risk (Gharar) should be avoided. The Islamic term “Gharar” is a broad concept encompassing different forms of uncertainty or risk. Islamic scholars apply the Gharar condition to excessive risk due to leverage.
- Parties should share risks and profits proportionately to their stakes instead of one party claiming most or all the upside or bearing the full risk of loss.
The above are not the only Sharia rules covering financial transactions and commerce. Other rules include the prohibition of gambling (Maysir) and the fact that commercial transactions should benefit society and refrain from supporting Haram activities, such as gambling or alcohol production.
Why Can Leverage and Margin Trading Be Considered Halal?
- Leverage does not inherently involve interest or Riba. The trader borrows capital and pays the broker a fee for the service to execute the trade rather than paying interest on a traditional loan.
- If the underlying asset in a leveraged trade is Halal, such as a currency pair or commodity such as gold, the leverage helps facilitate a larger trade, which is in itself Halal.
- Traders can use leverage responsibly—it is not a sign of greed or excessive risk-taking. For example:
- Traders can choose to keep extra margin on hand, which by default means they will need less leverage.
- They can use stop-losses and position sizing to control risk accordingly.
- They can also ensure using only risk capital they can afford to lose regardless of the amount of leverage in the trade.
- Certain Islamic finance scholars have approved leverage trading as Halal within pre-specified parameters.
These arguments state that using leverage is not inherently wrong and is permissible so long as traders use it responsibly for Halal trading activities.
Why Can Leverage and Margin Trading Be Considered Haram?
- Leverage is a tool for speculation rather than legitimate commerce, and leveraged trading is more akin to gambling, which Islam prohibits.
- Leveraged trading can result in losses that far exceed the movement of the underlying asset price and even the initial margin for the trade. This violates the principle of taking excessive Gharar or excessive risk.
- Leverage trading does not proportion the risk or reward between the broker lending the capital and the trader. The trader receives the magnified risk and the magnified reward rather than each party getting a proportion of the gain or loss.
- Many Islamic scholars consider the underlying instruments in leveraged trading, such as forex options, futures, and other derivatives, Haram. They see them as vehicles of speculation and gambling rather than investments in intrinsic assets.
What Is the Maximum Leverage Ratio Allowed in Islamic Finance?
While Islamic finance prohibits excessive risk-taking, no predetermined limits to leverage define excessive risk. Some may feel that 100:1 is excessive, while others may feel that it is appropriate. The risk also depends on the volatility of the underlying instrument. For example, a higher leveraged trade may be appropriate for a low-volatility major Forex pair.
Many countries’ regulators now restrict leverage to lower amounts, such as 20:1 or 30:1, helping Muslim traders remain within reasonable levels.
Can I Trade on Margin in an Islamic Account?
Yes. Islamic accounts have made great strides in helping Muslim traders remain compliant with Shariah principles and still use leverage for their trading. One example is ensuring that swap payments associated with leverage are fee-based rather than interest-based. Many of the world’s leading Halal forex brokers let traders access leverage across multiple Forex pairs without charging interest.
Bottom Line—Is Leverage Trading Halal or Haram?
The opinions among Islamic scholars can be divided into several categories:
- Permissible in moderation - leverage is acceptable within certain limits and regulations, such as using it responsibly with risk capital and with Halal instruments or securities.
- Forbidden.
- Permissible only for hedging - this is when leverage is used to hedge business transactions, such as an importer or exporter locking in the value of a currency pair to finance their transactions.
If you decide to use leverage, ensure that the underlying instrument is Halal. For example, many Islamic scholars consider Spot Forex and commodities such as metals Halal. Secondly, use an Islamic account which is designed especially for the needs of Muslim traders. Features of Islamic accounts include removing interest-based forex swaps or replacing them with a flat fee.
