Proprietary trading has evolved into a significant part of the trading landscape, offering traders a way to turn their trading dreams into reality and providing a source of income.
The exponential growth of the proprietary trading industry has triggered a pivotal question for Muslim traders: Do the services that prop firms provide adhere to Shariah principles?
This article explores how proprietary trading firms operate, what conditions make trading Halal, and whether proprietary trading firms align with Islamic financial principles.
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What Is Proprietary Trading?
Proprietary trading firms allow individuals to trade their capital.
Proprietary trading firms have existed for decades, but historically, traders could only access them from physical locations and trading rooms. Now that markets like retail Forex are electronic, the firms have moved to an online model where anyone can register.
How Do Prop Firms Work?
Most prop trading firms follow the below process or a variation of it:
- Evaluation Process
Traders pay a fee to undergo an evaluation. The fee can range from a few hundred to a few thousand dollars. The evaluation requires the client to trade the prop firm’s demo account over a certain period.
- Conditions to Pass the Evaluation Process
The trader must meet specific requirements to pass the evaluation process. For example:
- Minimum number of trading days
- A profit target
- Reaching a maximum loss level will end the evaluation
- Passing the Evaluation Period
The best Forex prop firms will allow the trader to make multiple attempts at passing without paying the fee again and refund the evaluation fee when the person passes the evaluation period.
- Funding an Account for the Trader
At this stage, the person can trade the prop firm’s capital in a live account. However, there may be conditions on their trading, such as maximum position sizes and no weekend trades. The starting balance of the funded account often depends on the evaluation fee: most prop firms have different fee levels, which results in different starting balances.
- Profit Split
Assuming the trader continues to be profitable, the prop firm will give a split of profits to the trader (usually monthly or quarterly). The percentage profit split to the trader ranges from 50% to as high as 90%.
Prop trading is a form of leverage.
The best way to understand prop firms is to view them as a form of leverage. If the prop firm funds a $100,000 account and I receive 50% of the profits, they have effectively given me a $50,000 account.
Halal and Haram in Trading
Many aspects of trading can make the activity Halal (permissible) or Haram (forbidden), but the most relevant aspect of proprietary trading is interest-based swaps.
How Do Swaps Work?
This could be the biggest obstacle to Halal trading with prop firms.
Leveraged securities such as Forex typically pay or receive a daily “swap” payment—the difference in interest payments between the long and short currencies in a Forex pair.
For example, if I go long EURUSD, I receive interest for being long Euros and pay interest for being short US Dollars. The broker bases the interest payments on the currencies’ central bank interest rates, i.e., the European Central Bank interest rate versus the U.S. Federal Reserve. The difference between the two interest payments is called a “swap.”
If the difference is positive, the trader gets a daily swap credit. If the difference is negative, the trader pays a swap charge.
Paying or receiving interest in Islam is forbidden, making swaps Haram.
How to Keep Prop Trading Halal?
The key to keeping prop trading Halal is to use a swap-free account.
Islamic accounts are swap-free, thus making them Shariah-compliant. While some brokers will only offer a limited swap-free period, the top Islamic account brokers will allow unlimited swap-free trading.
Does your chosen prop firm have an Islamic account option?
Prop firms will always insist on using their brokers, but they may have a swap-free or Islamic account option available to their traders. Instead of a swap, the broker has several options:
- Charge a Fixed Fee Instead of the Swap
This is usually a dollar per lot, and the dollar amount will vary depending on the swap; the trader always pays the fee to the broker, and the fee is independent of the interest difference between the two currencies.
- Only Apply a Swap or Fee for Trades Held Over a Specified Number of Days
In this case swaps are only triggered after a certain period. For example, some brokers will not apply the swap for trades open for less than five days in their Islamic accounts. After five days, the broker will apply the swap if the trade is still open.
- Widen Spreads
Rather than applying a swap, the broker will have wider spreads in their Islamic accounts.
Shariah-Compliant Alternatives for Prop Trading
If the prop firm does not have a Shariah-compliant option, the next option would be to seek more leverage from a Shariah-account. That could mean moving brokers. However, some warnings:
- Regulation
Do not move to a high-leverage broker that is poorly regulated. - Leverage Is Not Always Good H4
Remember, leverage magnifies losses as well as gains. It also heightens the psychological stress of trading an account. Plenty of traders have lost their accounts by using too much leverage.
Prop Trading for Muslims—Pros & Cons
Pros
- The best Forex prop firms have excellent profit splits and track records of paying out profits regularly and without delay.
- Prop firms provide structure, such as maximum position sizing and other risk controls, which is psychologically beneficial.
- Many brokers have swap-free Islamic versions of their accounts for prop firms.
- Prop firms provide traders access to additional capital.
Cons
- The evaluation fees can be costly and non-refundable if you do not pass.
- It is psychologically tough to trade a demo account in the evaluation phase and then transition to a large pot of capital in a funded account.
Bottom Line
The prop firm industry has matured to give traders access to capital with excellent profit splits. Prop firms also provide a structured trading environment, which psychologically benefits many traders. The key for Muslim traders is being allowed to trade a swap-free or Islamic account with the prop firm.
