The terms ‘trading’ and ‘investing’ are often used interchangeably, which means the difference in meaning has to be inferred from the context. But if you’re new to the world of stock markets, that might not be an easy task.
Let’s first start with what traders and investors have in common; they both:
Participate in the stock market
risk their own money
buy shares
sell shares
expect to gain a financial return for their efforts.
So what’s the difference?
The table below highlights the main characteristics of a trader and an investor.
Traders typically...
Hold on to stocks for a short amount of time – sometimes even seconds
do not expect to receive a dividend
actively buy and sell shares
gain financially solely by selling stocks for a profit
will accept smaller gains, but the gains will be more frequent
may expect 10% returns per month
Investors typically...
Hold stocks for a long time – sometimes even decades
expect to receive a dividends
do not actively buy and sell shares
gain financially through dividend income and sometimes through the sale of shares
reinvest dividends to buy more shares (thus creating a compound effect)
expect a large increase in stock value to justify loyalty shown to the stock
are usually happy with 10-15% return on investment on an annual basis
Being an investor suits people who don’t want to actively manage their portfolio or those who trust the management of a company fully.
The world’s most famous investor is Warren Buffet, who favours holding stocks forever. Buffett says if you don't feel comfortable owning a stock for 10 years, you shouldn't own it for 10 minutes. Some of the well known stocks he holds (through Berkshire Hathaway) include Coca Cola (held since 1988), American Express (held since 1993) and American bank Wells Fargo (held since 1989).
Being a trader, meanwhile, requires a lot more effort. There are, in fact, several categories of traders:
Position Trader
Swing Trader
Day Trader
Scalp Trader
Position Trader
Of all the types of traders, a position trader is the closest to an investor. A position trader may hold on to their ‘positions’ (shares they buy in a company) from months to years. In this time, they may very well qualify to receive a dividend as well.
Swing Trader
A swing trader holds positions from days to weeks. Holding stocks for weeks means a trader is very unlikely to qualify for dividends, so profits occur when share prices rise after purchasing them.
Day Trader
A day trader holds positions throughout the day, but makes sure to ‘close’ (sell their shares) before the stock market closes so they have no overnight positions. This may sound peculiar to you, but there’s a good reason for this. Some traders use something called ‘leverage’. A detailed explanation of this can be found in another article, but briefly using leverage allows traders to amplify their trade by buying more shares than they can actually afford by borrowing money from the share dealer. The share dealer will not charge you interest if you manage to repay the same day, but if you do not manage to repay, then you will be charged interested on an ‘overnight’ basis. This is problematic for Muslims for all sorts of reasons, and deserves an article of its own.
Scalp Trader
Scalp traders hold positions from seconds to minutes with no overnight positions. As you can imagine, there’s a lot of work involved being a scalp trader and this can only be done effectively using highly sophisticated computer applications. In order to buy and sell shares on a second-by-second basis, it means the trader has to be glued to their computer screens. So this is not something that professionals can realistically get involved in.
Like day trading, scalp trading also has potential problems according to some people. In Islam there is a rule which stipulates that one cannot sell something they do not own.
When shares are purchased, a certificate is issued. In the past this would have been a paper certificate, but nowadays it is a digital certificate. Some say that the share certificate proves ownership and if a trader is buying and selling shares on a second-by-second basis, then it gives rise to the possibility of selling stocks before receiving the share certificate (and therefore selling shares before becoming the owner of those shares).
Some further say that getting involved in this kind of trade opens the door to gambling. It has to be accepted that trading on a second-by-second basis makes it impossible to research a stock properly or check whether it passes shariah requirements (screening). Therefore many argue that this type of trading is best avoided as it could open the door to gambling.
This view is not without basis.
Zayd ibn Thaabit said, “Do not sell it in the spot where you have bought it until you take it to your house for the Messenger of Allaah, sallallaahu ʻalayhi wa sallam, forbade to sell the goods where they are bought until the traders take them into their possession.” [Abu Dawood].
Similarly…
It has been narrated on the authority of Ibn ʻAbbaas that the Prophet, sallallaahu ʻalayhi wa sallam, also forbade the resale of foodstuff by somebody who had bought it unless he had received it with exact full measure. [Al-Bukhari, Muslim, and others] Ibn ʻAbbaas also reported that the Messenger of Allaah, sallallaahu ʻalayhi wa sallam, said, “If anyone buys a grain, he should not sell it until he takes possession of it.” Ibn ʻAbbaas remarked, “I think all things are considered the same in this regard.” Another version reads, “I regard everything like food (so far as this principle is concerned).” [Muslim]
However, some scholars do explain that “taking into possession” in this context is determined according to the common practice. Therefore, if registering the shares in your account or transferring them to your online wallet, for instance, is considered an acceptable manner of taking possession of the shares by the buyer according to the definitions and practices of the stock exchanges, then this is acceptable in the shariah and the buyer is entitled to sell them after taking them into possession; otherwise, it would be impermissible.
Conclusion
If you want to participate in the stock market, you’ll need to decide whether you want to be a trader or an investor. This decision is something personal to you and depends on your own situation (for example, how much time you can dedicate, etc.).
I trade on the stock market to supplement my income- this is not my primary income. Therefore, it makes no sense for me to intentionally engage in scalp trading or day trading. There is a fine line between owning the shares and then selling it on (halal) and not owning the shares before selling it on (haram) in scalp trading. Likewise, taking on leverage in day trading is also problematic. Even with best intentions to sell stocks before being charged interest, people can easily find themselves in a position where it is not possible to sell in time (such as the internet connection being down in their area, forgetfulness, getting caught up in some sort of emergency, and so on). As Muslims, this sort of risk is simply not worth it.
If you are starting out on your trading journy, you may wish to consider my 30 Day Trading Programme, which covers Islamic principles of investing, learning the basics of the stock market and learning how to use a trading platform. The programme is totally flexible and is based on the principles of self-learning.
Further reading:
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