What are bonds and how do you trade them?

Bonds are a fixed-income instrument or debt security that represent a lending agreement between a buyer and seller, issued by either the government or a private corporation – effectively an ‘IOU’. Unlike shares that trade on a country’s national stock exchanges, most treasuries are traded over the counter (OTC)​.

The borrower promises to pay back the bond to the lender at a prior agreed date, and until then, are usually required to pay fixed or variable interest rate payments. Investors who purchase a security are lending money to the issuer for a specified period of time. Their duration can be short-term, medium-term or long-term depending on the individual treasury, and the funds are used to finance a project or operation.

The treasuries market is open 24 hours a day, from Sunday night to Friday evening, due to overlapping hours for each country and stock exchange. It’s generally a popular way for investors to diversify their portfolio​, due to the lower, more stable returns.

Types of bonds vary depending on the issuer, but most follow the same principle with these key features:

These are a loan to the government for an agreed rate of interest in return. As with all assets, it’s for an agreed period of time, with the interest paid at regular periods, and the original investment returned at the end of the time period, also known as the maturity date. In the UK, these are referred to as gilts, whereas in the US, they are known as treasuries.

These involve loaning capital to a company, as a form of debt security issued by a particular corporation and sold to investors. These are often used for a company operation or future project, although they may be considered a riskier type of bond as taxes can’t be used to pay and companies are more likely to default then, causing higher interest rates.

On the other hand, these are issued by cities or countries and other local institutions to finance infrastructure and expenditures. These often include schools, bridges or roads. An appeal of these is that the coupons paid out are usually tax-free.

Also known as "junk bonds​", these are of a lower status than others and tend to come from start-up businesses. Therefore, they have lower credit ratings and are more likely to default, making them slightly riskier investments. However, they can still be a good way to diversify your portfolio.

Treasuries can be used as a partial hedging strategy​ for when other equities, such as shares in the stock market, are experiencing a period of market volatility. If you encounter losses on other assets, then these may be partially offset by any profits that you make through debt investments as they sometimes have a negative correlation to riskier assets such as stocks.

Movements within the stock market can sometimes affect bond prices, and in particular, yields are sensitive to changes in interest rates. When interest rates fall, the interest rate on the treasury becomes more attractive. On the other hand, if rates go up, bond prices tend to fall, so there is less purpose for trading. Although this can increase the chance of risk, traders can use these types of assets to hedge against interest rate movements.

Overall, the treasury market produces returns of around 5-6%, according to CNN. Although this may seem low compared to the stock market’s average of around 10%, they also come with less risks and are considered by many to be a more stable asset. Therefore, treasuries may be suitable for an investor who is looking for slow and steady returns, rather than quick and volatile ones.

When spread betting bonds, you’re not required to pay tax or stamp duty*. Similar to other assets, traders often choose to go long if they expect the price to rise or short if they expect the price to fall.

A particular appeal of spread betting, which is our most popular derivative product, is the use of leverage. Traders are only required to place a relatively small deposit and trade on margin, which will grant them larger exposure to the market. Our margin rates for treasuries start at just 3.3% and for interest rates, they start at 20%.

However, spread betting is a leveraged product, meaning that while your profits can be magnified, losses will be equally if the markets move in the opposite direction, leading to an unsuccessful trade. For this reason, some traders choose to apply risk-management orders, such as stop-losses, in order to protect their capital as much as possible from volatility within the market.

Open a spread betting demo account to practise trading on the market with virtual funds.

Spread betting takes a different approach to investing. When investing, you would need direct access to the stock exchange that they’re listed on or a bond issuer, or another popular method is to buy an exchange-traded fund (ETF) that tracks the performance of multiple securities through one index. You would also receive interest payments on your open positions.

However, when you spread bet or trade CFDs, you’re only speculating on price movements and therefore won’t be entitled to such payments as you don’t own the underlying security. You can trade on both sides of the market, meaning that if you think a debt security’s value is due to fall, you can short sell and won’t be stuck with the investment you’ve paid outright for. There are pros and cons to each strategy, and this will come down to each individual’s preference. Please note, CMC Markets only offers exposure to these instruments via spread bet and CFDs.

Traders may opt for either short-term or long-term bond trading strategies depending on their overall goals. So, how does bond trading work? We explore several options below to help you get started.

As discussed, when interest rates rise, treasuries may become less appealing to a trader as their prices drop. If you believe that this is about to happen, you could ‘sell’ your chosen asset in order to open a short position which will profit when the price moves downwards. Then, if the price indeed drops as predicted, you could close out the trade by opening a long position to ‘buy’ back the asset at a lower price. Your profit would be the difference in price between the two.

Short selling is a risky strategy and may result in losses if the position is not managed properly, so in order to prevent this, you could place a stop-loss order on any open positions, which can help to limit your losses.

In an opposite strategy to the one above, if you think that interest rates are about to drop, which will drive bond prices higher, you could open a long position (also known as a buy and hold approach). You would make a profit if your trade increases in value and you close out the trade or ‘sell’ the asset for a higher price. However, remember that the markets can move in either direction and there is no guarantee that your prediction will be correct.

Another trading example is one of hedging. As prices can be affected by both interest rates and inflation, opening a trade is usually an efficient way to hedge against possible downturns in the stock and treasuries markets. A trader could potentially make a profit from the movement in prices through income generated from stocks or other assets held in your existing portfolio.

Traders looking to get exposure to fixed income could open a long position on (buy) individual assets. Depending on factors like time horizon, risk profile and available capital, a mutual fund or exchange-traded funds (ETFs) may also be among options worth considering.

Our instrument is based on the underlying security issued by the British government, which can have a maturity of five, ten, or 30 years. The political party has never failed to make interest or principal payments when they are due, therefore this is considered as one of the safest investments a trader can make. The treasury is made up of both conventional and index-linked gilts.

This is a treasury derivative based on the relative value of the fixed-interest, US debt security, which has a maturity of between 10 and 30 years. It often increases in value in times of economic or political instability as investors seek a safe haven to keep their money safe.

This instrument is based on the underlying price of the Euro Bund issued by the German federal government, and it’s one of our most popular treasury products. In most cases, these long-term options have a maturity range of between 8 and 10 years.

Our treasury note is based on the US debt security with a fixed interest and maturity of around two years. It’s included on the shorter end of the yield curve and provides a good indication of the health of the US economy.

The Bobl is Germany’s version of gilts and is based on the underlying value of a collection of medium-term German federal issued securities. Its underlying assets have a maturity of between 4 and 6 years. Bobl futures are some of the most popular fixed-income securities in the world.

Our US T-Note 10 Year – Cash instrument is based on a US debt obligation issued by the government with a maturity of 10 years. These pay interest at a fixed rate once every six months, paying the face value to the holder when it matures.

This ETF’s aim is to track the performance of an index made out of GBP denominated bonds. It has a fixed interest rate and helps investors to have a diversified exposure to government securities, as it provides single country exposure only.

The aim of this fund is to track the performance of a broad, market-weighted index in the US dollar-denominated market. It’s an intermediate-term instrument that can offer a potential for investment income.

This is one of the most commonly used ETFs for high-yield securities. It seeks to track the investment results of an index composed of US dollar-denominated high-yield corporate-grade securities. Investors often use it for income.

This fixed-income instrument provides exposure to US dollar-denominated junk bonds with above average liquidity. The index that it’s based on is a more cost-efficient method than accessing individual treasuries.

You can start spread betting or trading CFDs on more than bonds, interest rates, debt obligations, and treasury notes offered on our Next Generation platform. Some of our most popular instruments trade up to 23 hours a day, giving you a wider exposure to the markets.