This means that fixed income securities provide no ownership of the issuing organization, but rather a right to a contracted payment structure for interest and principal payments, as well as collateral in the case of default and priority in the case of bankruptcy.
Fixed Income in the Investing World
Fixed income securities are more commonly known as bonds. They are contrasted with equity, which is a share in the ownership of the issuing company. Fixed income securities instead provide a steady stream of income and a means of recouping some or all of the principal owed in the event of a default or bankruptcy.
Investors use fixed income investments for a variety of reasons. Some investors use fixed income as a simple hedge for an equity-heavy portfolio, as fixed income securities tend to rise as equities fall. Other investors rely on the regular interest payments for their own finances when sporadic equity dividends are too erratic.
High-yield bonds, or ‘junk bonds‘, are more prone to defaults and may offer higher yield rates than many equities.
Trading in Fixed Income Securities
Fixed income securities represent such a wide range of securities that it is difficult to represent them all in general terms.
Most of the trading done in the fixed income sector involves calculations around the timing of interest and principal payments and the likelihood of defaults.
Day traders who are comfortable with mathematics and mathematical programs will find they can better navigate the valuation of fixed income securities, but day traders who solely focus on researching the likelihood of defaults can also trade competitively.
The chance of a default occurring can be a highly subjective issue, which means that many fixed income securities may be significantly underpriced or overpriced when the market is misreading the odds of a default.
While default rates may often depend on more objective issues, such as company finances, they can also depend on the market’s subjective interpretation of relevant events, which can often be substantially wrong.
Day traders who find that they have a knack and a passion for studying default rates will do well in the trading of fixed income securities.
These securities also often follow some of the same technical patterns as equities and commodities, though it is important that day traders also understand the underlying valuation of the securities before applying technical analysis.
Fixed Income Securities and Central Banks
The value of fixed income securities ultimately depends on the rate of interest on government debt, as this rate is considered to be the lowest risk.
Therefore, as the rate of government debt rises, existing fixed income securities will fall in value as investors can achieve higher yields from buying newly issues debt.
This is one of the reasons why national interest rate decisions are followed so closely, and why the market can react so suddenly to unexpected interest rate moves.
While all investors should make a habit of tracking the activities of the major central banks in the world, and the activities of those central banks of the nations that they commonly trade in, day traders who venture into fixed income securities should take particular care of central bank activity.
Even the comments of non-voting members of the Federal Reserve at commencement speeches for universities have been known to affect the value of fixed income securities, and any day trader who is unprepared for these events can find their positions lose value rapidly and unexpectedly.
Fixed income securities represent a huge range of securities that can serve a variety of purposes for investors.
Day traders who wish to venture into the world of fixed income should be aware of the influence of the payment structure of the securities, the default risk of the issuing organization and the activity of relevant central banks.
That said, fixed income does offer many profitable opportunities for day traders, including many of the same technical patterns seen in the market for equities.