5 Bond Trading Strategies (Treasury) – (Video, Backtest, Example, Performance, Setup, 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.

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