Interest Rate Futures Trading And The Yield Curve
Interest rates are very important for the economy as well as the businesses. No matter what business you do, interest rate changes can have an impact on your business. No matter what you trade-stocks, forex, futures, commodities, ETFs, options, bonds or anything else, you need to keep an eye on the interest rate changes. Now, there is not one interest rate in the economy. There are many. Some are short term while others are long term. A Yield Curve helps you understand the changes in the different interest rates in the economy!
You will come across three types of shapes on the yield curve. The normal curve rises to the right and the short term interests are lower than the longer term interests. A normal yield curve represents normal economic activity where investors are being rewarded more for investing in longer term securities with a premium on longer term interest rates.
The second type of yield curve that you will come across is the flat curve where the short term interest rates are equal or almost equal to the longer term interest rates. When you spot a flat yield curve, this is a sign of an economy that has started to slow down.
However, when the economy starts to go into a recession, you will suddenly find an Inverted Yield Curve. On an Inverted Yield Curve, the longer term interest rates are lower than the short term interest rates.What this mean is that the economy is slowing down and investors are reluctant to invest long term thinking it to be risky. An Inverted Yield Curve is a leading indicator of an economy doing down into a recession. When there is a financial crisis like that happened in the early part of 2008, you will find the Yield Curve to be Inverted. Investors are shying away from investing in long term projects in the economy.
Another very important thing that you need to understand before you invest in long term bonds is that the longer the time period of maturity, the higher will be the volatility of that instrument. In other words, longer term bonds and financial instruments require higher yields in order to attract investors. But, longer term bonds and instruments are highly susceptible to good or bad news in the market. In other words, they show a lot more volatility as compared to short term instruments.
If you want to trade interest rates short term than Eurodollars are the best instruments that you can trade. Eurodollars are well suited for small traders because of the low margin requirements. Eurodollars also tend to be less volatile and have a highly liquid market due to the large number of market participants. However, like any other futures contracts, Eurodollars position needs to be carefully monitored. Ten Year T Notes and T Bonds can be highly volatile. You can also trade options on these interest rates futures.
Trading interest rate futures is no different than trading other futures contracts. When you trade interest rate futures, you need to pick your entry and exit points carefully including the worst case scenario that might include taking a margin call. You also need to keep in mind what the economic calendar has in store for you for that day.
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Article Source: ArticlesBase.com
