A Primer on Trading Bonds, and Interest Rate Products

William Addiss on Oct 31, 2025

Although the bond market is larger in size than the equity market, most investors are much more comfortable with stocks than bonds. Yet the volatility of interest rates presents many opportunities for active traders. However, like any market it requires education and a commitment to understanding the product. This article is intended to serve as a primer for those interested in exploring these opportunities further.

 

  1. Bonds Trade in the Over-The-Counter (OTC) Market

    Despite its size, the US bond market is completely OTC (over the counter), meaning that there is no exchange trading for bonds. The result of no centralized trading means bonds don’t offer the liquidity, price transparency and benefits that exchange trading brings. For that reason, I often suggest that traders look at Bond ETFs (Exchange Traded Funds)

     

  2. Bond ETF’s are much more liquid trading vehicles than the bonds themselves.

    By repackaging a bond portfolio and creating an ETF, investors now benefit from the transparency and liquidity of an exchange. For example, an often-quoted ETF is symbol TLT. This is an ETF, sponsored by Blackrock, of just 20-year treasury securities. So, the investor trading that ETF is effectively trading the 20-year treasury bond, with the enhanced benefit of trading it in ETF form

     

  3. Remember: There is always an inverse relationship between interest rates and bond prices

    Fundamental to understanding bond trading is understanding the relationship between bond prices and bond yields. Simply put, as/if interest rates were to rise, the result is previously issued bonds at a lower yield become less valuable (Price dropping if yields rise). Conversely, if interest rates were to drop, that makes the value of excising bonds with their hgher coupons more attractive (Prices rising if yields drop). Perhaps the illustration below will serve as a reminder

     

  4. Interest rates do not move in a linear fashion. Short-term, and long-term rates move independent of each other

    Here in the US, we have Treasury Securities with maturities as short as one month, and as long as 30 years. When we look at a graphic representation of the yields available on those various treasuries, we get what is called “The Yield Curve”. The chart below illustrates this point. The red line shows us the yield curve at the start of 2024. You can clearly see that interest rates at that time were rather abnormal, with short term rates being substantially higher than long term rates (this phenomenon is called an “inverted yield curve”). However, looking at the blue line, by the end of the year, the curve had changed dramatically. Short-term rates were down substantially, thanks to “The Fed” cutting short-term rates by 1% over the year. Yet, as you can see, during that same period long-term rates actually ROSE by 1%. The point is, the yield curve is dynamic, rates and the curve changing constantly, and the factors that affect short term rates are dramatically different than the factors affecting long term rates

     

    A graph on a black background AI-generated content may be incorrect.

                                                                                                                    Source: USTreasuryYieldCurve.com

     

  5. Understanding duration is critical to understanding bond trading.

As a former professional bond trader (23 years with Lehman Brothers), I can assure you firsthand, THE most Important factor to understand when actively trading bonds is a concept called Duration. This actually is a rather complex mathematical concept, but simply put, the duration of a bond tells you how volatile any bond will be, given a 1% change in interest rates. The higher the duration the more volatile the bond will be, and similarly, the lower the duration, the less volatility you will experience. Without getting lost in the weeds (or in this case the math), the important point to highlight is that the single most important consideration in determining a bond’s duration is its maturity. The longer the maturity of a bond, the more volatile it will be.  Perhaps the visualization below will help reinforce this point:

 

 This article was intended as both a primer in understanding bonds, as well as to help demystify some of the unique “jargon and lingo” of the bond market.  Obviously, when considering the trading opportunities and risk present in any asset category, education is key. Whether through the monthly XLT which I host, or the one-day Focus Class entitled: Bonds- The Canary in the Coal Mine, and the weekly companion classes for graduates of that program, I welcome the opportunity to assist you in that understanding of this exciting market