How to minimise risks when trading bonds in Hong Kong?

How to minimise risks when trading bonds in Hong Kong?

 

Experienced bond traders know that they can’t live without risk management when trading. This is because, in any investment market, there are risks involved. And when you are dealing with bonds, the risk can be huge.

 

One of the biggest mistakes investors make is failing to realise the importance of managing their risks wisely. They are so afraid of losing money that they either put all their eggs in one basket or invest heavily in risky stock options.

 

Suppose you want to avoid making these mistakes and maximise your returns. In that case, you need to have a sound bond trading strategy that will allow you to minimise your losses and capture the upside potential when there is an opportunity for high returns.

Be aware of the risks

When trading bonds in Hong Kong, you need to be aware of the following risks:

Credit risk

Credit risk is the risk that the bond’s issuer will not repay the principal or interest when it comes due. This can happen if the company goes bankrupt or experiences a financial crisis. In Hong Kong, credit risk is especially high for junk bonds, which companies issue with a low credit rating.

Interest rate risk

Interest rate risk is the risk that the market interest rates will rise, causing the value of your bond investment to decline. For example, if you buy a 10-year bond and interest rates go up by 2%, then the value of your investment will drop by 20%.

Liquidity risk

Liquidity risk is the risk that you will not be able to sell your bonds at a reasonable price. This can happen if there aren’t many buyers in the market or existing bondholders demand higher fees from new investors.

 

Market risk

Market risk refers to the risks involved in investing in the overall market and not just in a particular bond. For example, if you invest in the stock market and the market crashes, your investment will also be worthless.

Risk management strategies

There are several strategies that you can use to help manage your risks:

Diversification

This is the strategy of investing in various assets to reduce your overall risk. For example, you could invest some money in high-risk stocks and some in low-risk stocks if you invest in stocks. You could invest in various bonds in the bond market instead of just focusing on one or two.

Position sizing

This means you should only put a certain percentage of your overall portfolio into high-risk investments while keeping the rest in lower-risk options. For example, if you have HK$200000 to invest, don’t place all of that into a single investment option because if it doesn’t work out, you will lose a lot of money. If there are ten different options available to choose from, then you can put HK$200000 into five different investing opportunities (position sizing). When one doesn’t work out, you won’t lose everything and still have some money to invest in the other options.

Hedging

Hedging is an investment technique where you ensure that the potential loss of one option is offset by another option that will generate profits if your primary investment fails. For example, if you put all your money into a junk bond, but it goes bankrupt, then you should also invest in stocks at the same time so that gains on your stock position offset any capital losses incurred on the junk bond.

Shorting

This involves borrowing securities and selling them to repurchase them at a lower price to pocket the difference between what you sold it for and what you paid to repurchase it (when prices drop). This is known as shorting because you are selling something before buying it. So when prices drop, you would have made a profit on the price difference.