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Adnan Ally Mamode Jaumdally
According to Zaman (1986), "Muslims are encouraged to seek economic bounties which God has made available to them." From the above it is evident that Muslims are increasingly interested in investing in halal securities traded in stock markets all around the world in order to earn the economic benefits. However, one needs to predict the future value of a stock prior to making any decision either to buy or to sell the asset. Hence, there is a great deal of speculation involved in stock markets. This has raised the issue, in the Islamic arena, of whether speculation in the stock markets is gambling and thus forbidden. The Quran clearly prohibit us from gambling as illustrated by the following verses relating to games of chance or gambling, referred to in Arabic as maysir;
Allah SWT says;
"They will ask thee about intoxicants and games of chance. Say: In both there is great evil as well as some benefit for man; but the evil which they cause is greater than the benefit which they bring." Quran (2: 219)
"By means of intoxicants and games of chance Satan seeks only to sow enmity and hatred among you, and to turn you away from the remembrance of God and from prayer. Will you not, then, desist?" Quran (5:90)
The Messenger of Allah (SAW) also forbade us from gambling as illustrated in the following Hadith;
From Abu Hurayrah (RA), that he said, "The Messenger of God (S) forbade the 'sale of the pebble' [hasah] [sale of an object chosen or determined by the throwing of a pebble], and the sale of al-gharar. [Sahih Muslim]
Ibn Taymiyah (ra, nd) expounds on the above Hadith to explain gharar as the consequence of which is unknown and goes further to claim that selling it involves maysir, which is gambling. Maysir or gambling is prohibited in Islam because it causes enmity and hatred and also involves consuming property bi-al-batil, which is a type of oppression. Being given the obvious prohibition of gambling in both the Quran and the Hadith of the Prophet (SAW), it is of utmost importance to determine whether speculation in the stock market is similar to gambling.
Several scholars have addressed this issue, from different angles. Kamali (1996) defines speculation as consisting of "the intelligent and rational forecasting of future price trends on the basis of evidence and knowledge of past and present conditions". Based on the Quranic verses and the Hadith of the Prophet (SAW), Ibn Taymiyah (ra) pointed out that if a sale contains gharar and devours the property of others, it is the same as gambling, which is clearly forbidden. Therefore, for a transaction to be equated to gambling, it must involve the devouring and unlawful appropriation of the property of others. Against this backdrop, speculative risk taking in commerce, which involves the investment of assets, skills and labor, is not similar to gambling. This is because the buyer is engaged in a transaction aimed at making profit through trading and not through dishonest appropriation of the property of others.
Maysir has also been described as involving two parties in a combative game played for the sole purpose of winning at the expense of one's opponent. The gain accruing from such a game is unlawful, as is the act of playing it, for it diverts one's attention from productive occupation and virtuous conduct. Applying this definition to commercial speculation on stocks, it can be said that speculation does not necessarily involve a combative game played in order to beat an opponent or to acquire his/her property. However, the speculative risk undertaken is more closely associated to commercial risk taking for profit rather than gambling.
El-Ashkar (1995) also addresses the same issue. He defines speculation as "the practice of (a) using available information to (b) anticipate future price movements of securities so that (c) an action of buying or selling securities may be taken with a view to (d) buying or selling securities in order to (e) realize capital gains and/or maximize the capitalized value of security-holdings." From this point of view El-Ashkar argues that the decision taken in speculation is not result of the turn of a card or casting of a dice. However, it is a process that relies on the analysis of a lot of economic and financial data, companies' financial reports, political decisions, information about management skill and aptitude and the personal profile of the decision makers. That is to say, speculation is an activity that requires a great deal of knowledge and skills. Therefore, speculation in stock markets cannot be equated to gambling.
The above description of El-Ashkar relies on the availability of information to differentiate speculation from gambling. It seems that the absence of information or even the lack of it may mean that speculation may become very close to gambling. However, this is not necessarily so as it would mean that all other decisions made with lack of information, not related to stock markets, will be gambling. Hence, the lack of information should not be confined to speculation only.
The sale of gharar is said to lead to maysir (gambling) which leads to oppression and is therefore prohibited in Islam. It is evident that gharar is not present in speculation in stock markets as each party is clear to the quantity, specification, price, time and place of delivery of the object. Moreover, the object of the transaction, which is the purchased security, is available in the market at the time of transaction and is, bound to be available at the time of delivery. Therefore, speculation has no element of gharar and, hence, does not lead to maysir.
The above discussion has proved that although speculation in the stock markets may look like gambling, yet it is by no means akin to gambling. Speculation has both pros and cons. Its positive side is that it can help stabilize prices and activate a market where there is thin trading. It can also provide signals to less-informed investors upon which to act. The negative effect of speculation is that excessive amount of it may cause volatile price movements in the market. It can thus be concluded that excessive speculation should not be allowed, but a reasonable degree of it be permitted. Quantitative limits on daily trading volume and legislative guidelines may help contain speculation within healthy bounds.
Thomas Tellner
Though I agree that participating in the stock market is not 100% speculation, I think some qualifications need to be made. I have held a Series 7 stockbroker license in the United States for the past ten years. In addition, I have studied Finance at the University of Maryland, where I attained my Bachelor's of Science.
My only response to Adnan is regarding the definition of "speculation".
While many dictionaries may define "speculation" as forecasting, pondering or conjecturing, in some form or the other, in Finance, and especially in stockbrokerage, it carries a slightly different connotation. In fact, it is a rather derogatory connotation.
Bro. Jaumdally write, regarding speculation, "...it is a process that relies on the analysis of a lot of economic and financial data, companies' financial reports, political decisions, information about management skills and aptitude and the personal profile of the decision maker". Financiers would call this as financial planning, budgeting, or investing. Finance is concerned with risk reduction. Speculation involves risk-taking.
In the brokerage industry, we casually divide our clients into two general groups: investors and speculators. The investors research the companies in which they wish to invest, basing their decisions on their studies. Speculators often know nothing of the companies whose stock they buy. Investors buy pieces of ownership in the underlying companies. Speculators buy shares as commodities.
As a practicing broker, I can personally bear witness that many of the speculators not only know nothing of the companies in which they "invest", they often do not know the companies' name - just the ticker symbol used to report price movements.
Jaffer Manek
The above explanation is good for the definition of gambling and speculation.
It is established that advertisers are able to get small investors to pump in their life savings month after month in the hope of pensions on retirement, unit trust gains and endowment insurance policies maturing to pay 25 years mortgage loans. They derive £$millions every month even when the stock market bubble is too inflated due to a shortage of a steady supply of new shares arriving on the stock market.
The writer proposes " ... excessive speculation should not be allowed, but a reasonable degree of it be permitted. Quantitative limits on daily trading volume and legislative guidelines may help contain speculation within healthy bounds."
What precisely would result in a democratic process which gives freedom to the investing public in their speculation activity and choice? How can it all be done without corruption, privilege, fraud, state intervention or police involvement?
And on top of that, how can it be achieved in the globalize trading 24 hours a day? And allowing people from different cultures and attitudes in the whole world also to be able to invest freely? That my friend is the real challenge but please attempt a suggestion.
Thomas Tellner
There are two issues brought in the above posts:
1). the most fair and efficient method of controlling speculation. 2). The issue of justifying speculation on the grounds it has some advantages. I wish to reply to both. This is a rather lengthy reply, so I beg your collective forgiveness in advance. The second point is easier to address, so I will comment on that first.
Speculation is not a source of "signals to less-informed investors" investors. Not, at least, in the manner the author implies. Speculation has little to do with the true value of the underlying company. It has everything to do with forecasting current and future sentiment as to the price of the stock itself. Speculators buy stock; investors buy companies. The successful speculator in the words of a famous investor is "profit from other people's stupidity". Speculation is based largely on sentiment, which has no solid foundation or standard of measure, so it does not "stabilize prices". Granted, it may lend liquidity to thin markets, but if a security is thinly traded, it is probably traded that way for very good reasons.
This is a quick review of some thoughts on speculation in the markets. Speculation lends to volatility in prices and this is very de-stabilizing. This reeks havoc for the value investor. The New York Stock Exchange has admitted as much and has undertaken audits of the largest firms in the United States in order to review their policies toward speculators and their activities, called "day trading". This leads us to the second point, or the first point listed above, from Bro Maneek's post.....
As an employee of Waterhouse Securities, I am very familiar with the new attitude toward day trading. Waterhouse was one of the first firms to be audited since we handle the second largest Internet trading volume in the country. Since November of last year, the Internet stock group has led the way through extreme volume and volatility in the markets. The advent of easy access to Internet trading has also lent its share to the rise in both volume and volatility.
At the end of the audit, the NYSE sat down with Waterhouse, and together drew up new guidelines for controlling day trading. Though the examples below are specific to Waterhouse as a firm, this is the direction that all firms will be following in the near future, subject to some guidelines specific to each firm. This is not merely a suggestion for controlling speculation, as the author of the post had asked for - this is policy now. Whether it is vulnerable to any of the disadvantages the Bro. Maneek suggests it might be subject to, I leave to your judgment.
Firstly, we will confine our discussion to day trading in Cash Only Accounts. This is an account where the purchaser makes a purchase and then is expected to pay in full for this purchase. This purposefully excludes Margin Accounts, where the buyer borrows a certain portion of the cost and therefore is charged interest. Hopefully, we can all see why we, as Muslims, would not need to treat the use of interest-bearing accounts for investment.
With that said, we'll review the simple activity in a Cash Account. I will name our fake speculator after myself for want of another name, for example purposes only.
Step 1: Thomas buys $10,000 of ABC stock on April 1
Step 2: Thomas must pay $10,000 to his account for ABC on April 4
The current regulations stipulate a 5-day settlement: 3 days regular and a 2-day grace period to allow for mail time etc.
Now, if ABC has wild price swings, I might be able to day trade this. For example:
Step 1: Thomas buys $10,000 of ABC
ABC rises in price.
Step 2: Thomas sells $12,000 of ABC = $2,000 profit.
ABC falls back in price:
Step 3: Thomas buys $10,000 of ABC
ABC rises in price
Step 4: Thomas sells $14,000 of ABC = $4,000 profit.
Looks easy, doesn't it? As a matter of fact, the serious and experience speculator does this sometime DOZENS of times a day. This is further evidence against speculating. The prices DO NOT RESPOND to the speculator, but rather the speculator responds to the prices.
But there is something hidden in this activity. Let's add a factor and take it slower. We need to add the amount of money Thomas has in his account.
Step 1: Thomas has $5000 in his account
Step 2: Thomas buys $10,000 ABC = Thomas owes $5,000
Now, Thomas must pay $5,000 in 3 days.
Step 3: Thomas sells ABC for $15,000 = $5,000 profit
Now, in 3 days, Thomas now has $15,000 in his account after selling ABC
In three days, the firm will take $10,000 from Thomas' account, and credit back to him $15,000 from the buy and sale respectively, netting him $5,000, as predicted by the simple math above.
Day traders, as I said above, do this constantly. Until the recent audits by the NYSE, they could do this as many times as they wanted in a day. Here are the new restrictions:
#1 Restriction on Aggregate Purchases:
Aggregate purchases must not exceed cash available
Step 1: Thomas has $10,000 in his account. ($10,000 cash available)
Step 2: Thomas buys $10,000 ABC
Step 3: Thomas sells $12,000 ABC = $2,000 profit.
Then:
Step 4: Thomas buys $10,000 XYZ
Step 5: Thomas sells $11,000 XYZ = $1,000 profit.
With the second sale, Thomas has violated the restrictions. He bought $10,000 ABC as well as $10,000 XYZ during the day. This adds up to $20,000 aggregate purchases. But Thomas only had $10,000 available. If Thomas delivers the extra $10,000 in the 5 allowed business days, or does not sell the XYZ the same day, he will not be in violation. If he does not, his account will be restricted to Cash-in-Advance purchases for 90 days. This is called a "90-Day Restriction".
Usually, Thomas WILL NOT deliver funds. He believes that when he sold $12,000 of ABC, he then had that money to use AGAIN, to buy XYZ. However, the NYSE does not look at it this way. He had not yet paid for the ABC, since settlement was not for 3-5 more days. So, when he bought and sold XYZ, he was profiting off of funds that were not there and had been earmarked for something else, namely, the ABC purchase.
#2 "Free-Riding" Restrictions
All purchases must be paid-in-full before their sale.
Step 1: Thomas has $5,000 Cash Available
Step 2: Thomas buys $10,000 ABC
Step 3: Thomas sells $12,000 ABC = $2,000 profit.
Here, with the sale of stock which he had not paid for, and has no intention of paying for since he thinks the sale will cover the buy, Thomas will also be placed in a "90-Day Restriction". Thomas has in fact, though for only a small amount of time, used someone else's money to pay for his trade. Someone, usually the brokerage firm, has to produce the original $10,000. Thomas has only $5,000, so the firm makes up the other $5,000.
When the proceeds of the sale arrive, the firm takes its $5,000, gives Thomas his $5,000 AND his $2,000 profit. The firm has basically lent Thomas $5,000 of funds, free of charge - no interest, no service charge, no consideration whatsoever. This is an abuse that is being targeted by this restriction.
In conclusion, the two above methods of speculating have been widely used. In the near future, they will become harder to commit these types of activities. It is obvious that Thomas had controlled TWICE as much stock as he really should have been able to control. With his activity, and the similar activities of millions of other speculators who often control THREE, FOUR, FIVE and even TEN times the money in their accounts, the prices of securities can be skewed far away from their realistic values. This activity is not meant in order to help find the "true" price of a stock. It is used to reap profits using other people's money and can cause immense devaluation of long-term investors' portfolios. These two restrictions alone will seriously hamper the speculator from controlling more stock than he is financially capable of paying for, and restrict the size of trades be bought and sold in speculative frenzies.
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