How to Trade Bonds: A Complete Guide for 2025

What Are Bonds and How Do They Work?

Bonds are debt securities representing a loan from an investor to a borrower, typically a government or corporation. When you purchase a bond, you lend money to the issuer in exchange for periodic interest payments and principal repayment at maturity.

The issuer sets a par value (usually £1,000), a coupon rate (annual interest percentage) and a maturity date. You receive coupon payments at regular intervals — typically semi-annually — until maturity, when the issuer repays par value.

Bond prices move inversely to interest rates. When rates rise, existing bonds with lower coupons become less attractive, causing prices to fall. When rates decline, existing bonds with higher coupons increase in value.

Three terms matter most.

• Yield represents your actual return, accounting for both coupons and any discount or
  premium to par.

• Duration measures price sensitivity to rate changes; a bond with five-year duration will
  decline approximately 5% for each 1% rate rise.

• Credit rating assesses the issuer’s default likelihood.

Bond trading involves interest rate risk, credit risk and liquidity risk — factors examined throughout this guide.

Types of Bonds in Finance

Government bonds are issued by national governments to fund public spending. UK gilts and US Treasury bonds are generally regarded as low credit‑risk compared with other securities, though all investments carry risk including potential loss of capital. UK gilt yields ranged from 3.8 to 5.5% across various maturities as of September 2025.

Corporate bonds are issued by companies to raise capital. Investment‑grade bonds (rated BBB‑ or higher) come from financially stable companies. High‑yield bonds come from companies with weaker credit profiles and offer higher coupons. Higher yields accompany higher default risk.

Inflation‑linked bonds, such as UK Index‑Linked Gilts, adjust both principal and interest based on inflation indices. They protect purchasing power but typically offer lower initial yields than conventional bonds.

Bond funds and ETFs pool capital to purchase diversified portfolios. They provide instant diversification and professional management but trade at market prices and may not return your original investment.

Bond Type — Typical Yield (2025) — Credit Risk — Liquidity — Minimum Investment

Note: Yields are indicative and vary by maturity and issuer. All bonds involve risk of loss.

Bonds vs Stocks: Key Differences

Bonds and stocks serve different portfolio purposes. Stocks represent ownership with potentially unlimited upside but risk total loss. Bonds represent debt obligations with contractually defined returns and priority in bankruptcy.

Bonds generate predictable income through coupons, making them suitable for steady cash flow needs. Stocks may pay dividends, but their primary appeal lies in capital appreciation.

When equity markets decline, investors often shift capital to bonds, causing bond prices to rise. This negative correlation provides portfolio diversification.

If you hold an individual bond to maturity and the issuer does not default, you receive your principal back. Stocks have no maturity date and no guarantee of recovering initial investment.

Consider bonds when you need predictable income, lower volatility or portfolio diversification. They suit investors approaching retirement or anyone seeking to reduce overall portfolio risk.

How to Buy Bonds: Step-by-Step Process

Direct purchase or bond funds is the first decision to make. Individual bonds may return par value at maturity if the issuer does not default, although repayment depends on the issuer’s creditworthiness. Bond funds offer instant diversification and easier trading but have no fixed maturity. If you have less than $50,000 to invest, funds typically provide better diversification.

Where to buy depends on the bond type. UK government gilts can be purchased through the Debt Management Office for new issues or stockbrokers for secondary market trading. Corporate bonds require a broker.

Step‑by‑step process:

• Choose your broker based on bond selection, fees and account types.

• Open and fund your account.

• Research available bonds using the platform’s screener.

• Review the bond’s prospectus, noting call provisions and covenants.

• Check the current bid‑ask spread.

• Place your order, specifying quantity and order type.

• Confirm settlement and ensure sufficient funds.

Minimum investments vary. UK gilts start at $100 through some platforms. Corporate bonds typically require $1,000 to $2,000.

Transaction costs include trading commissions ($12 to $20 per trade), bid‑ask spreads and platform fees. These costs can significantly impact returns on small positions.

How to Trade Bonds for Beginners

The primary market is where new bonds are first issued at par value. The secondary market is where previously issued bonds trade between investors at fluctuating prices based on rates, credit quality and liquidity. Most individual investors access the secondary market.

Bid‑ask spreads represent the market maker’s compensation. The bid is what buyers pay; the ask is what sellers demand. UK gilt spreads are typically narrow, around 0.05–0.10%. Corporate bond spreads can reach 1–2%. You lose this spread immediately when trading.

Reading bond quotes: Bonds quote as a percentage of par. A quote of 98.50 means $985 per $1,000 par value. You also pay accrued interest — coupon interest accumulated since the last payment date.

Order types: Market orders execute immediately at the best price. Limit orders specify your maximum price, providing control but risking non‑execution. Given lower bond trading volumes, limit orders often make sense.

Begin with small positions in liquid securities such as short‑dated gilts. Benchmark gilts often trade with daily volumes in the hundreds of millions to billions of pounds range, ensuring tight spreads.

Treasury Bonds: Government-Backed Securities

UK gilts encompass bonds issued by Her Majesty’s Treasury. They divide into conventional gilts with fixed coupons and index‑linked gilts that adjust for inflation. Maturities range from under five years to over 50 years.

Credit risk is minimal; the UK has never defaulted on sterling‑denominated debt. However, interest rate risk remains. During 2022, when rates rose sharply, long‑dated gilts declined over 30%.

US Treasury bonds include T‑bills (under one year), T‑notes (2 to 10 years) and T‑bonds (over 10 years). They introduce currency risk for UK investors. Exchange rate fluctuations can substantially impact returns.

Yield curves reflect the relationship between yields and maturity. Normally, longer‑maturity bonds offer higher yields. As of September 2025, the UK gilt curve showed yields of 4.0% for two‑year gilts and 4.8% for 10‑year gilts.

Purchase gilts through the Debt Management Office for new issues or stockbrokers for secondary market trading. Most major platforms including Interactive Investor, Hargreaves Lansdown and AJ Bell provide gilt trading.

Bond Trading Strategies and Risk Management

Buy and hold investors purchase bonds and hold to maturity, collecting coupons and receiving par value at maturity. This eliminates interest rate risk if you do not sell early and minimises trading costs.

Active trading attempts to profit from rate movements or credit changes but requires greater expertise and incurs higher costs.

Common strategies:

• Laddering: Stagger maturities across multiple years. As each bond matures, reinvest proceeds into a new bond to maintain the ladder structure. Laddering provides liquidity and reduces timing risk but does not eliminate reinvestment or credit risk.

• Barbell: Combine short‑term and long‑term bonds while avoiding intermediate maturities.

• Bullet: Concentrate holdings around a single maturity date, suitable for a specific future cash need.

Interest rate risk management requires an understanding of duration. When rates are expected to rise, reduce duration by favouring short‑maturity bonds. When anticipating rate cuts, extend duration. However, rate forecasting is difficult; laddering is more reliable for most investors.

Credit risk assessment involves reviewing credit ratings and issuer fundamentals. Annual default rates for investment‑grade bonds are typically low during periods of economic stability, but are significantly higher for high‑yield bonds. Diversify across issuers; avoid concentrating more than 5% in a single corporate issuer.

Material risks include interest rate shifts (a 1% rate rise typically reduces long‑term bond prices by 8–12%), credit deterioration, liquidity constraints and inflation erosion. Manage through diversification, appropriate duration and credit quality standards.

Tax Implications of Bond Trading

The taxation of bond income and capital gains varies by jurisdiction, but most tax systems distinguish between interest income (coupon payments) and capital gains (profits from selling bonds at a higher price).

In general:

• Interest income from government or corporate bonds is typically taxed as ordinary income at your prevailing rate.

• Capital gains on bond sales may be subject to capital gains tax, depending on the holding period, account type, and local exemptions.

• Some jurisdictions offer tax-advantaged investment accounts that can shelter bond income or defer taxation until withdrawal.

Investors should also consider whether government bonds receive different treatment from corporate bonds — in some markets, government debt may be partially or fully exempt from capital gains tax, while interest remains taxable.

The impact of taxation on returns can be significant. For example, a nominal bond yield may be reduced substantially after taxes if held in a standard account, whereas the same bond held within a tax-advantaged structure could retain its full yield.

Tax laws and rates vary globally and may change over time. Investors should seek advice tailored to their individual circumstances and local regulations.

Account Type Overview

Common Mistakes to Avoid When Trading Bonds

• Ignoring credit risk: Chasing yield without adequate credit research can lead to losses. Research ratings, financials and news before purchasing corporate bonds.

• Misunderstanding duration: Underestimating rate sensitivity can create mismatches with your horizon. A bond with 8.5‑year duration will lose roughly 8.5% if rates rise 1%.

• Poor rate timing: Forecasting central bank moves is difficult. Implement laddering to average entry points instead of trying to time the market.

• Overlooking liquidity: Infrequently traded bonds can have wide bid‑ask spreads. Check recent trading volume before buying.

• Tax inefficiency: Holding high‑yield bonds in taxable accounts while leaving ISA allowances unused wastes returns.

• Excessive trading costs: Commissions and spreads erode returns. Trade only when justified.

• Neglecting inflation: A 4% nominal yield becomes 1% in real terms at 3% inflation. Consider inflation‑linked bonds or shorter maturities.

Start with small positions in liquid, high‑quality bonds. Expand into complex securities only after understanding mechanics and risks fully.