Bond Trading

Bond trading means buying and selling debt securities, or products based on them, to profit from changes in interest rates and credit conditions. Because bond prices move opposite to yields, a bond trader is really trading a view on where rates are going. Bond markets are larger than stock markets in total value and they set the interest rates that ripple through every other asset.

Ways to trade bonds#

Yield is the price#

Bond traders talk in yields more than prices. When the 10 year Treasury yield rises from 4.20% to 4.30%, a 10 basis point move, the price of that bond falls. How much it falls depends on its Duration.

What moves bond yields#

1. Central bank policy: expected changes to policy rates move short term yields most. See The Federal Reserve and the FOMC.
2. Inflation: higher expected inflation pushes yields up. See Inflation and CPI and PCE.
3. Economic data: strong growth and jobs data tend to raise yields; weak data lowers them. See Employment Data and Non-Farm Payrolls.
4. Supply: large government borrowing means more bonds to sell, which can push yields up.
5. Risk sentiment: in crises, money often flows into government bonds, pushing yields down.
6. Credit risk: for corporate bonds, worries about default widen the yield spread over government bonds. See Credit Spreads.

Reading the yield curve#

The yield curve plots yields across maturities. Normally longer maturities pay more. When short term yields rise above long term yields, the curve is inverted, which has often preceded US recessions, though not with precise timing. Traders also trade the shape itself with steepener and flattener positions. See Yield Curves and Yield Curve Trades: Steepeners, Flatteners and Butterflies.

Trading Treasury futures#

Treasury futures, such as the 2 year, 5 year, 10 year note and 30 year bond contracts, are among the most liquid futures in the world. They let traders take rate views with leverage, hedge bond portfolios or trade around data releases. Their price moves opposite to yields, and each contract has its own tick value, so size positions from your stop and tick value as with any future. See Futures Trading.

Bond ETFs vs individual bonds#

An individual high quality bond held to maturity returns its face value, so price swings along the way do not matter if you hold it. A bond ETF never matures; its price keeps moving with rates. For trading, ETFs and futures are more convenient. For locking in a known return over a set period, individual bonds or Treasury bills can suit better.

Costs and practical points#

• Many individual corporate and municipal bonds trade infrequently, with wide and opaque spreads.
• Treasury bonds and major bond ETFs trade with tight spreads.
• Interest accrued between coupon dates is added to the price you pay, called accrued interest.

Frequently asked questions#

Can you lose money trading bonds?#

Yes. If yields rise after you buy, prices fall, and longer duration bonds fall more. Corporate bonds can also lose value if the issuer's credit weakens.

What is the most traded bond?#

US Treasury securities are the most traded bonds in the world, and the 10 year Treasury note is a global benchmark.

Why do bond prices fall when rates rise?#

Because existing bonds pay fixed coupons. When new bonds pay more, existing ones must fall in price until their yield is competitive.

Sources#

• TreasuryDirect, Treasury marketable securities
• U.S. Securities and Exchange Commission, Bonds