How do retail traders trade interest rates?

G

gaussian

I'm struggling to grasp how people are speculating on these. Obviously I could approach it via technical analysis but being more quantitative I would like to learn how to trade these a little bit more mathematically. I know very little about bond trading right now.

I understand there are various spreads though I don't understand how to trade them very well. I picked up The Treasury Bond Basis in hopes of learning more about this fascinating market. As a retail investor is the Treasury Bond Basis book a good starting point to leap into trading these instruments or am I wasting my time and I should go back to more TA/traditional ways of analyzing these? If anyone has any other books as well I'd like to know more.


Thanks!
 
It isn't anything obscure or esoteric. You can either quite literally trade interest rates (as in the yield curve) or indirectly trade interest rates (trade bonds,notes futures contracts). I do the latter mostly. To trade yield curve you'd have to trade the spreads, so buy one futures contracts and another one to make the proper spread. For example, you can trade something called the NOB (floor trader lingo I believe?) which is the 10 yr note against the 30 yr bond. Buying 3 ZN and selling 1 ZB or vice versa. However, you can just buy the futures contract outright if you want to indirectly trade the rates. So, if you think rates are going down, you can expect bonds to go up so just buy ZB contracts (obviously there's more to this I am just simplifying the relationship). Hope that clears it up. Nothing mystical or arcane.

Edit: Also, just to specify a little about trading the yield curve: You can trade it whether you think it's steepening or flattening. Check out this very informative mini guide from CME.
https://www.cmegroup.com/trading/interest-rates/files/Yield_Curve_Strategy_Paper.pdf
But if you're starting out, I would suggest trading the outright futures contracts, such as ZB/ZN.
 
fube said:
It isn't anything obscure or esoteric. You can either quite literally trade interest rates (as in the yield curve) or indirectly trade interest rates (trade bonds,notes futures contracts). I do the latter mostly. To trade yield curve you'd have to trade the spreads, so buy one futures contracts and another one to make the proper spread. For example, you can trade something called the NOB (floor trader lingo I believe?) which is the 10 yr note against the 30 yr bond. Buying 3 ZN and selling 1 ZB or vice versa. However, you can just buy the futures contract outright if you want to indirectly trade the rates. So, if you think rates are going down, you can expect bonds to go up so just buy ZB contracts (obviously there's more to this I am just simplifying the relationship). Hope that clears it up. Nothing mystical or arcane.

Edit: Also, just to specify a little about trading the yield curve: You can trade it whether you think it's steepening or flattening. Check out this very informative mini guide from CME.
https://www.cmegroup.com/trading/interest-rates/files/Yield_Curve_Strategy_Paper.pdf
But if you're starting out, I would suggest trading the outright futures contracts, such as ZB/ZN.
More...

Thank you for the reply. Do you have any opinion on the book I posted? Also, do you find trading the outright to be more technical or fundamental?
 
gaussian said:
Thank you for the reply. Do you have any opinion on the book I posted? Also, do you find trading the outright to be more technical or fundamental?
More...

To be honest, I remember coming across that book before, and from what I remember, I think it was more academic-leaning. As in equations, understanding the math behind yields etc. Which for a day trader wouldn't provide much edge or value (I think). You'll want to understand broader themes such as what moves the rates, what would lead the feds to think it's a good idea to hike rates, etc. The math behind it renders somewhat unhelpful if you're day trading the outright (At most you can maybe give yourself the satisfaction of understanding how the future contract for the ZB is priced and why the $ per tick is $31.25, etc).
As to your second question, I think it can be both. It depends on how you want to use it. Same can be said of stocks. Some people trade stocks strictly technically, others trade the fundamentals.
If you want to day trade the outright (let's say ZB) then the technicals should be prioritized. Knowing the fundamentals gives you more context, but the real, and arguably only, important "intraday" fundamental would be the day of FOMC speech, which is, I believe, the only important "intraday" fundamental when it occurs during the 6(?) times per year. Other than that, implementing fundamentals only for day trading ZB wouldn't be too helpful I think. You can just keep certain things in mind like: 1. Ok sentiment is rates going up. 2. Inflation is going to X, 3. Generally the sentiment for the fundamentals is bearish. But the thing is that these instruments (ZB, ZN, ZT, ZF, etc) move relatively slowly intraday and are typically directional, so technicals will provide you with more edge in that respect. If you swing it, then both technicals and fundamentals are critical. So depends on your style of trading.
 
gaussian said:
I picked up The Treasury Bond Basis i....is the Treasury Bond Basis book a good starting point to leap into trading these instruments
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Yes, it is an excellent book, but a difficult read. It might be a bit dated -- it's been around at least 25 years, which is when I read it. You may have to read parts several (many!) times before you finally have it down. I carried it around for eight months, re-reading it at lunch, in airports, etc. until it was finally stolen in an airport departure lounge in West Palm. I wasn't that sorry to see the last of it. The guy who lent it to me never asked for it back, so I think he was glad to be rid of it too.
 
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