In the exciting world of financial market, we tend to see stocks and crypto enjoying the limelight on social media.
However, did you know that the relatively ‘less exciting’ global bond market is actually larger than the global stock market?
According to the Securities Industry and Financial Markets Association (SIFMA), the global bond market was worth $126.9 trillion at the end of 2021, compared to the $124.4 trillion global equity market cap.
In this post, let’s explore what is bond all about, and why one should consider trading bonds!
What is a bond?
Bond is a form of debt that governments or companies issue to investors for a fixed period of time, in exchange for regular interest payouts.
Companies issue bonds to raise capital for ongoing operations or new projects, while government sells bonds to raise funds to supplement income from taxes.
In other words, as an investor, when you invest in bonds, you are lending money to governments or companies that will pay you interest in return.
Bonds are favoured among certain investors as it is (generally) a safer and less volatile asset compared to stocks (as it pays fixed interest, a.k.a. coupon).
As such, moving capital from stocks to bonds helps preserve capital from stock market fluctuation, though one may lose the opportunity for higher gains from the stock market.
Characteristics of bonds
Maturity: A bond’s maturity refers to the date when the bond issuer returns the money lent to them by investors. There are short, medium, to long-term bonds.
Coupon rate: The fixed rate of interest that the bond issuer pays to its investors. As an example, if I invest $1000 in a bond with a 4% coupon rate, then I’ll get $40 per year until the bond’s maturity date.
Duration risk: Bond’s price is highly sensitive to changes in interest rate. The longer a bond’s duration the higher exposure its price has to the fluctuation in interest rates.
How to invest or trade bonds?
There are many ways for everyday people like you and me to gain exposure to bonds. Below, let me list a few common ways:
#1 Bond Exchange-Traded Funds (ETFs)
Buying bond ETFs is the simplest way for everyday investors to gain exposure to bonds in their portfolios.
Since these ETFs are listed in the stock market, buying bond ETFs is similar to buying any stocks.
In my opinion, bond ETFs are suitable for investors that are simply looking to invest in bonds for the long term thanks to the low expense ratio of most bond ETFs.
Popular bond ETFs:
Vanguard Total Bond Market ETF (BND) - Exposure to government and corporate bonds in US .
Vanguard Total International Bond ETF (BNDX) - Exposure to government and corporate bonds in developed markets.
That said, for short-term trading, I’d be more inclined to trade bond futures instead of ETFs due to the nature of higher access to leverage of futures, as well as the liquidity and transparency of the futures market.
#2 Bond Futures
Bond futures is another way one can access the bond market.
Compared to ETFs listed in the stock market, futures market allows for higher leverage and more flexible directional trade (eg. no Pattern Day Trading restriction).
In addition, all volume and liquidity of bond futures go through the Chicago Mercantile Exchange (CME), which makes volume transparent to traders – and hence an additional piece of trading info.
RELATED READ: Why I trade futures over stocks
For me, futures is my go-to instrument to trade the bond market.
Commonly traded bond futures:
ZN – 10-Year Treasury Bond Futures
ZB – 30-Year Treasury Bond Futures
#3 Mutual Funds
Mutual funds, or unit trusts with bond exposure is also another way to gain exposure to the bond market.
With mutual funds, investors take a backseat/passive manner as fund managers decide how the build the fund.
Why trade bond futures?
In this section, let’s explore why traders should consider adding bond futures to their trading arsenal:
Bond futures have ample liquidity
A big challenge that traders face while trading is slippage due to a lack of liquidity (ie. Lack of buyers or sellers at respective price levels).
Meanwhile, the 10-Year Treasury Bond Futures (ZN) is one of the most liquid products (or ‘thick’, as I’d like to call it) in the futures market.
As a result, it is much easier to get your bond trades filled during active trading hours (most of the time) at your desired price compared to products with less liquidity such as the NASDAQ futures (NQ).
Bond futures is less erratic
Since bond futures like the 10-Year Treasury Bond Futures (ZN) is a thick market, its movement tends to be slower and more composed compared to thinner markets like the NQ as it takes a bigger effort to move the market.
As such, bond futures is a good choice for beginners and seasoned traders looking to trade a slower-paced market, as well as new traders looking to learn how to read the tape on the Depth-Of-Market (DOM).
Verdict: Consider the opportunities from trading the bond market
As a whole, the bond market offers great opportunities for beginner and seasoned traders alike.
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Disclaimers
Any of the information above is produced with my own best effort and research.
This post is produced purely for sharing purposes and should not be taken as a buy/sell recommendation. Past return is not indicative of future performance. Please seek advice from a licensed financial planner before making any financial decisions.
Leverage is a financial tool that comes with its advantages and risks. Please learn and understand both the upsides and downsides of leverage before using it for trading.
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