Proven Bond Trading

There are a lot of traders who focus primarily on the stock market, paying hardly any attention to the bond market. And this indifference is a missed opportunity because bonds can be very suitable trading vehicles and even complement strategies in the stock market. Many traders ask the question, “Is bond trading possible to be profitable? How am I able to optimize profit in trading with bonds?
In this article, we will cover four specific bond trading strategies to improve your trading portfolio. We discuss what bonds are, why you should trade them, and specific trading strategies that have performed well in history.

You will be able to know how to trade bonds easily and the benefits of considering bond trading strategies in your investment approach by the end of this article.

Understanding Bonds

What is a Bond?

A bond is essentially a loan by the investors to the borrower-which can be a company or government. The periodic interest payments and return of principal when the bond matures are made in form of an exchange for lending money. This structure makes bonds fundamentally different from stocks, with which this paper more closely relates as the shareholders have ownership stakes in a company.

Are Bonds Less Risky?

Generally, bonds are considered less risky than equities, at least partly because in the event of insolvency, bondholders are ranked ahead of shareholders. All things being equal, government bonds are considered the safest, corporate bonds involve much more risk, and junk bonds carry even greater but promise higher return risk.

What Moves Bond Prices?

Various factors like credit, interest rate, and inflation risk affect bond prices. Existing bonds typically see a fall in price with an increase in the interest rate and vice versa. All these dynamics have to be considered before undertaking profitable bond trading.

Why Trade Bonds?

Benefits of Trading Bonds

Trading in bonds can be a rewarding affair as well as profitable in nature. Trading in bonds has numerous benefits:

1. Less Volatility: Treasury bonds are less volatile as compared to stocks in an unsure market situation.
2. Diversification: Bonds have a proven low correlation with stocks. This gives a smoother ride of the portfolio through market fluctuations.
3. Regular Income: They offer fixed returns in the form of interest payments which can then be reinvested or utilized in any form or for any requirement.

There often isn’t much of a seasonal pattern between the S&P 500 and long-term U.S. Treasury bonds, meaning bonds can be an excellent hedge against the volatility of the stock market.

Four Bond Trading Strategies

Strategy 1: Monthly Seasonal Strategy

Trading Rules:

Buy on the seventh last trading day of the month.
Sell at the close of the month.

This easy seasonal strategy has produced a flat equity curve at an annual return of 5.45%, which was achieved more than any buy-and-hold that included dividends, with the point of reminder that this strategy only spends 28% of the time invested.

Strategy 2: Reverse Monthly Strategy

Trading Rules:
Short at the end of the month and cover at the close of the seventh last trading day of the following month.

Another approach was characterized by good performance also, and indeed, an annual return of 4.41% was achieved since the underlying ETF, TLT rose for the same period by 4.6%. The trading short positions sometimes are tricky, but this result proves that indeed, it is a valid approach.

Strategy 3: Combined Monthly Strategy

Trading Rules:

• Buy TLT on the seventh last trading day of the month.
• Short at the end of the month.
  It falls on the seventh trading day of the new month.

Strategy 1 together with strategy 2 resulted in high returns. An investment of $100,000 turns into an amount of $735,000 after 20 years with an annual return of 10.25%, more than double a buy and hold strategy. This strategy illustrates the strong strength of seasonal patterns and lack of correlation to returns on stocks.

Strategy 4: Long Bond Strategy with Dual Variables

Trading Rules:

Buy TLT based on one price action variable and one seasonal variable.
Exit on strength.

This strategy has not been described in full as it is part of our membership program, but it has traded at an average per trade gain of 0.44 with annual returns approximately 4.8%. Its low maximum drawdown from equity peaks makes it reliable.

Benefits of Trading Bonds

1. Ease of Implementation: The strategies below are pretty straightforward and can be applied by various traders regardless of experience.
2. Diversification: Adding bonds to your portfolio would diversify the account, thus improving the overall nature of volatility.
3. Risk Management: Bonds act as a cushion when stocks hit a bear market, thus providing more resilience to your trading strategy.

Conclusion

Bond strategies is another area which helps with diversification, and can, hopefully, enhance the return with a healthy management of the risk. Generally, higher profits might be also available in equities, but bonds maintain balanced portfolios very well.

If you’re interested in exploring more trading strategies, these bond strategies may be useful for you to include in your trading plan. All trading strategies inherently hold risks, and it is crucial to backtest and validate any strategy before actual capital is put at risk.

In combination with the stock strategies that you are likely already using, bond trading strategies might help you attain a better return with fewer drawdowns. Stay tuned for our next video, where we break down mean reversion strategies applied within the stock market; that could be quite useful for enhancing your toolbox.

Thanks for reading, and remember, this content is not investment advice. Have a great trade!