5 Bond Trading Strategies

5 Bond Trading Strategies (Treasury-Fixed Income) – (Video, Backtest, and Rules)

Bond trading strategies are a great inclusion in a portfolio of strategies because they offer diversification and, most likely, uncorrelated returns. Bonds are complementary.

First, you might want to have a look at other articles related to bond trading strategies:

Despite being much larger than the stock market, the bond market gets much less attention from short-term individual traders. That’s a shame because bonds are great trading vehicles. This article will explore bonds and show you examples of how you can trade them. Why would you trade bond trading strategies?

This article examines Treasury bonds and shows you several backtested bond trading strategies. We don’t examine corporate bonds (which are mainly traded in the over-the-counter market) but Treasury bonds.

Here you can find more than 200 trading strategies similar to the above strategies.

What is a bond?

A company or sovereign state that issues a bond (the borrower) gets money from investors (the lender). Investors provide capital to the borrower in exchange for a promise from the issuer to pay interest on a fixed schedule for a certain period of time and to pay back the principal when the bond matures.

Let’s give an example:

You might want to invest one million in a ten-year bond paying 3% semiannually. That means you get 15 000 every six months until the bond matures, and you get back the outstanding one million (hopefully).

But investing in bonds involves risk, and you need to overcome the following three risks:

  • Credit Risk: The borrower (issuer) might get into financial trouble during the ten years and fail to honor the semiannual payments and might not return the one million.
  • Interest Rate Risk: If you need to raise money or sell the bond prior to maturity, the price of the bond might change. If rates are higher now than when you invested, the bond’s price is lower (and vice versa).
  • Inflation Risk: Even if you hold the bond until maturity, you might “lose” due to lost purchasing power.

What is a bond trading strategy?

Bond Trading Strategies

A bond trading strategy refers to a systematic approach or plan used by investors to buy or sell bonds in the financial markets. These strategies are designed to achieve specific objectives such as capital preservation, income generation, or capital appreciation. Bond trading strategies can vary widely depending on factors such as market conditions, investor risk tolerance, and investment goals. Common bond trading strategies include yield curve strategies, duration strategies, credit spread strategies, and tactical asset allocation strategies. Yield curve strategies involve taking positions based on expectations of changes

How do bond trading strategies differ?

Bond trading strategies differ based on time horizon, risk tolerance, and market conditions. Some focus on short-term gains through techniques like scalping, while others take a longer-term perspective, relying on fundamental analysis. Risk levels vary, with some strategies prioritizing high returns and others emphasizing capital preservation. Market environment also influences strategies, with some traders adopting defensive approaches in uncertain times and more aggressive tactics during economic expansions. Overall, strategies vary in their objectives and approaches to navigating the bond market.

What are common mistakes in bond trading strategies?

Common mistakes in bond trading strategies often stem from insufficient understanding of market dynamics, overreliance on historical data without considering current conditions, and neglecting risk management principles. Traders may also fall into the trap of chasing yield without fully assessing credit risks or liquidity constraints. Additionally, misjudging interest rate movements or failing to diversify adequately can lead to significant losses. Lack of flexibility in adjusting strategies in response to changing market conditions is another common pitfall. Finally, emotional biases such as overconfidence or herd mentality can cloud judgment and result in poor decision-making. Successful bond trading requires a comprehensive understanding of the market, disciplined risk management, and the ability to adapt to evolving circumstances.


Bond trading example

Let’s show you how the price of a bond varies.

Three years back, you invested one million into ten-year Treasuries with a paltry 0.5% semiannual yield which pays 2 500 every 6 months.

However, the stock market has crashed in the meantime, and you want to sell the bonds to invest in stocks. Stocks are cheap.

But unfortunately, interest rates have risen, and no buyers are willing to pay what you paid for them. As a matter of fact, not only stocks have crashed, but also bonds because interest rates have increased. Because of the increased rates, bond prices need to go down. Today the bid is at 80 for your bonds. Thus, your one million investment is only worth 800 000. Quite a loss! This is interest rate risk, and it’s for real.

We hope you get the point on why bond prices fluctuate.

Related reading: Bond Glossary

Is bond trading profitable?

That depends on the strategy, of course. But as you’ll discover in this article, the main benefit of bond trading strategies is that they are complementary and add to the overall returns.


Why bond trading strategies are good

Bonds are volatile, but the best part is that bonds usually don’t correlate too much with stocks. They are complementary.

The chart below shows the 25-day rolling correlation between SPY and TLT (red line). The black line is the 200-day moving average. SPY tracks S&P 500, while TLT tracks Treasury 20-year bonds.

As you can see, the correlation goes up and down, but the black line is around zero most of the time, indicating no correlation (the blue line marks zero):

Bond trading strategies correlation

If you want a primer on correlation, please see our separate article:

Bond trading strategies backtests

We assume you are most interested in specific bond trading strategies.

Let’s look at some specific bond trading strategies. The strategies below are backtested on the ETF that tracks 20-year Treasury bonds (TLT), but they can most likely be traded by using the corresponding futures contract, given you use the same official trading hours as TLT.

Bond trading strategy backtest 1

Our first bond trading strategy was published a few years ago and called Calendar Effects In Long-Term Treasuries.

The trading rules are simple (this is a seasonal strategy):

Trading Rules


The strategy has returned the following equity curve since TLT’s inception in 2002:

Bond trading strategies
Bond trading strategies

The trading statistics and metrics are good:

The return is more than twice buy and hold despite being invested just 61.8% of the time. If we look at the risk-adjusted return it’s even better at 16.2%.

We argue these are “spectacular” returns for such a “simple” strategy! We believe seasonal patterns are one of the lowest-hanging fruits in trading, but there is no guarantee the pattern will continue working in the future.

Bond trading strategy backtest 2

Our second bond trading strategy is the monthly trading edge from June 2021. It trades TLT and has three variables to decide when to buy and a straightforward exit criterion.

Below is the equity curve since TLT’s inception in 2002:

The performance metrics and statistics are good:

  • No. of trades: 273
  • Average gain per trade: 0.38% (0.96% for winners and -1.16% for losers)
  • Win ratio: 72%
  • Profit factor: 2.1
  • CAGR: 4.8%
  • Exposure/time in the market: 15%
  • Max. drawdown: -9%

Bond trading strategy backtest 3

We have more bond strategies; the next one is also in TLT and was our monthly trading edge for our subscribers in December 2022.

It’s a seasonal strategy that trades from the short side. It has two variables: seasonal and intermarket (we use another market/asset as input). Below is the equity performance since 2002:

  • No. of trades: 200
  • Average gain per trade: 0.58%
  • Win ratio: 63%
  • Profit factor: 1.9
  • CAGR: 5.3% (assuming no leverage)
  • Exposure/time in the market: 25%
  • Max. drawdown: -13%

Bond trading strategy backtest 4

The following strategy is also a long swing trade in TLT and was our monthly trading edge for March 2023. It has one price action variable and one based on a seasonal effect.

It has the following equity curve from 2002 until today:

The historical performance is good and we get the following trading statistics:

  • No. of trades: 238
  • Average unleveraged gain per trade: 0.44% (1.0% for winners and -1.09% for losers)
  • Win ratio: 73%
  • Profit factor: 2.4
  • CAGR: 4.8% (assuming no leverage)
  • Exposure/time in the market: 13%
  • Max. drawdown: -8%

Bond trading strategy backtest 5: combing with S&P 500

One of the main reasons for why including bonds are diversification. They are complementary.

To show you how we’ll combine our TLT strategies with one of our strategy bundles for S&P 500.

Let’s start by showing the backtest results of our beginner strategy bundle in S&P 500 from 2002 until today, which trades SPY or the futures contract (ES):

The results are very good and uncorrelated to the overall market return (buy and hold). The average gain per trade is 0.6%, and the annual unleveraged return is 10.5% – significantly better than buy and hold despite being invested just 23% of the time.

But what happens if we include bond strategies 3 and 4 mentioned above? The result improves a lot:

5 bond trading strategies
5 bond trading strategies

The annual returns increase from 11.5% to 18.6% while drawdowns decrease. This is precisely why we want to add complementary strategies, and this shows that bond strategies add valuable diversification. Drawdowns decrease even though we spent more time in the market (50%) after we added the bond trading strategies.


Bond trading strategies – conclusion

This article has shown how to improve your trading by adding complementary bond trading strategies. If you want to take your trading to a higher level, you are likely better off by adding strategies that might not be “perfect” on their own but work nicely together with other strategies.

You are not looking for the perfect strategy but strategies that complement each other.

Bond trading strategy
Bond trading strategy

How do interest rates impact bond trading strategies?

Interest rates have a significant impact on bond trading strategies. When interest rates rise, bond prices tend to fall, and vice versa. This inverse relationship forms the basis for many bond trading strategies. For instance, in a rising interest rate environment, traders may employ a strategy known as “riding the yield curve,” where they invest in longer-term bonds to capture higher yields before rates climb further. Conversely, in a falling rate environment, traders might favor shorter-term bonds to minimize the risk of capital loss from decreasing yields. Additionally, interest rate expectations influence bond trading decisions. If market participants anticipate future rate cuts, they may buy bonds in anticipation of their prices rising as yields decline. Conversely, if rate hikes are expected, investors may sell bonds to avoid potential losses from falling prices. Overall, understanding and effectively navigating the relationship between interest rates and bond prices is essential for successful bond trading strategies.

Can bond trading strategies be automated?

Yes, bond trading strategies can indeed be automated. With advancements in technology and the rise of algorithmic trading, many aspects of bond trading can be programmed to execute trades automatically based on predefined criteria. Automated trading systems can analyze vast amounts of data, including market trends, interest rate movements, economic indicators, and bond issuer information to make informed decisions in real-time. These systems can also incorporate various trading strategies, such as trend following, mean reversion, or statistical arbitrage, which can be coded into algorithms. Additionally, automation can enable swift execution of trades across multiple markets and instruments, allowing for efficient portfolio management and risk mitigation. However, it’s important to note that while automation can enhance trading efficiency, human oversight is still crucial to monitor and adjust these automated strategies as market conditions evolve.

Are there specific bond trading strategies for beginners?

For beginners, there are specific bond trading strategies to consider. One such strategy is dollar-cost averaging, where you invest a fixed amount regularly regardless of market conditions, reducing the impact of market fluctuations on your overall investment.

Similar Posts