From the January 01, 2012 issue of Futures Magazine • Subscribe!

How to understand and trade the bond market

Getting started

The major Treasury contracts, five- and 10-year notes and 30-year bonds, are based on a 6% coupon rate equaling par or 100-00. So is the ultra-bond, which is a 30-year bond that has at least 25 years left to maturity. Each full tick is worth $31.25; there are 32 ticks in a point or handle, equaling $1,000 per contract. Five- and 10-year notes also have 32 ticks in a point, but each tick is subdivided. The 10-year is traded in half-ticks with each half-tick worth $15.625, and the five-year is traded in quarter-ticks with each quarter-tick worth $7.8125. Because longer-term Treasuries tend to have higher yields, they tend to be more sensitive to interest rate movements. A news event that may cause a full handle move in the long bond typically results in a 16-24-tick move in the 10-year and less than a half-point move in the five-year.

Broz offered two pieces of advice to beginning bond traders: Start with five- and 10-year notes, and trade multiple contracts. "If traders can use a stop of one tick in five-years, two ticks in 10-years, then they can get entry prices you like, and [lower] your risk," he says. Broz explains that although there may be "less bang for your buck" than in the 30-year, there also is less risk. "You can learn how to get in the market, manage your trade, eke out a few ticks a day. That’s unique because for guys that trade the S&P, that’s not really even an option."

Additionally, Broz says that trading a second contract helps you protect your profitable trades. "There are too many novices that are told to trade a one-lot. To me, that’s a losing game when that one-lot is a winner and you take profits and it keeps going your way. Now you have nothing on," he says. "I stress to newer traders that they have to trade a two-lot. With that two-lot working, if the market goes their way one tick, then they can take one off, move a stop to scratch and then who knows what may happen."

Finally, Spencer says the best tools a bond trader needs are his eyes and brain. "Observe, observe, observe different types of relationships. Bonds don’t trade in a vacuum. You’ve got to be aware of the influences that are out there. If you walk in in the morning and the prices are different than when you left, find out why," he says.

Getting started in bond trading is just like learning to trade any other commodity. You have to understand what it is you’re trading, and know how and why it moves the way it does. Like any endeavor, you’re not going to be perfect at first

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