What is Asset Rotation?
Asset rotation is a trading strategy that involves selling the expensive asset and buying the cheap asset based on their historical price relationship. The most common application is rotating between similar bonds like GD30 and AL30.The core principle: When two similar assets diverge from their typical price relationship, you bet on mean reversion by taking opposing positions.
Understanding the Ratio Concept
What is a Bond Ratio?
The ratio between two assets is simply:- GD30 price: $60,000
- AL30 price: $55,000
- GD30/AL30 ratio: 60,000 / 55,000 = 1.0909 (or 9.09% premium)
Why Ratios Matter
For similar bonds (same issuer, similar characteristics):- The ratio typically trades in a predictable range
- Extreme highs suggest Asset 1 is expensive vs Asset 2
- Extreme lows suggest Asset 1 is cheap vs Asset 2
- Traders profit by betting on mean reversion
How to Visualize Bond Ratios
You cannot determine if an asset is expensive or cheap without viewing the historical ratio.Using TradingView
The Asset Rotation Strategy
Core Principle: Buy Cheap, Sell Expensive
When executing asset rotation:- Identify which asset is relatively cheap vs expensive (using ratio analysis)
- Buy the cheap asset
- Sell the expensive asset for the same total amount
- Wait for the ratio to move in your favor
- Close both positions when the ratio normalizes
Critical Rule: Equal Dollar Amounts
Wrong approach:- Buy 10,000 nominal AL30
- Sell 10,000 nominal GD30
- Calculate total dollar amount for one position
- Use the ratio to determine the nominal amount for the other position
Complete Example: GD30/AL30 Rotation
Opening the Position
Market conditions:- GD30 price: $60,000
- AL30 price: $55,000
- Ratio: 60,000 / 55,000 = 1.0909 (9.09% premium)
Buy the cheap asset (AL30)
- Nominal to buy: 55,000 = 109.09 bonds
- Round to 10,909 nominal (10.909 bonds × 1,000 nominal)
- Total cost: 10,909 × 5,999,950
- Long: 10,909 nominal AL30 (cost: $5,999,950)
- Short: 10,000 nominal GD30 (proceeds: $6,000,000)
- Net cash: $50 (approximately market neutral)
Closing the Position
Time passes… new market conditions:- GD30 price: 1,000 or -1.67%)
- AL30 price: 500 or -0.91%)
- New ratio: 59,000 / 54,500 = 1.0826 (8.26% premium)
For simplicity, this example excludes commissions and market fees. In practice, subtract approximately 0.10-0.20% total cost from your profit.
Understanding the Math
Why Equal Dollar Amounts?
Asset rotation is a market-neutral strategy. You’re not betting on the overall market direction, only on the relative performance of two assets. If you use equal nominals:- You’re exposed to overall market direction
- If markets fall 10%, you lose money even if your ratio bet is correct
- Long and short positions offset
- You profit purely from ratio movement
- Market direction has minimal impact
Calculating Nominals from Ratio
Given:- Asset 1 nominal amount (N1)
- Ratio (R) = Price1 / Price2
- Selling 10,000 nominal GD30
- Ratio = 1.0909
- Need to buy: 10,000 / 1.0909 = 9,167 nominal AL30
When to Enter and Exit
Entry Signals
Ratio at Historical Extremes
Ratio at Historical Extremes
When the ratio reaches the top or bottom of its historical range:
- High ratio: Asset 1 is expensive → Sell Asset 1, Buy Asset 2
- Low ratio: Asset 1 is cheap → Buy Asset 1, Sell Asset 2
Divergence from Moving Average
Divergence from Moving Average
When the ratio deviates significantly from its moving average:
- Calculate 20-day or 50-day moving average of the ratio
- Enter when current ratio is 2+ standard deviations away
Fundamental Changes
Fundamental Changes
When news or events cause temporary mispricing:
- One bond has unusual selling pressure
- Liquidity differences create short-term dislocations
Exit Signals
Ratio Normalization
Ratio Normalization
Close when the ratio returns to its historical average or your target level.
Profit Target
Profit Target
Set a predetermined profit target (e.g., 2% of notional) and close when reached.
Stop Loss
Stop Loss
Set a maximum loss threshold (e.g., -1% of notional) in case your hypothesis is wrong.
Time-Based Exit
Time-Based Exit
Close after a certain period if the ratio hasn’t moved as expected.
Risk Management
Key Risks
Divergence Risk
The ratio may continue diverging instead of reverting. Use stop losses.
Structural Changes
Fundamental changes can permanently alter the ratio relationship.
Liquidity Risk
One asset may become illiquid, making it hard to close positions.
Execution Risk
Prices move between opening the first and second leg of your trade.
Risk Mitigation Strategies
Monitor correlations
Ensure the two assets remain fundamentally similar (same issuer, currency, etc.).
Execute both legs quickly
Minimize timing risk by executing buy and sell orders in rapid succession.
Beyond GD30/AL30
Other Bond Pairs
The ratio strategy works for any similar asset pairs:- AE38 / AL29: Similar duration sovereign bonds
- GD35 / GD38: Different maturities, same issuer
- Provincial bonds: Pairs from the same province
Criteria for Good Pairs
What makes a good ratio pair?
What makes a good ratio pair?
- Same issuer: Reduces credit risk differences
- Similar maturity: Reduces duration risk differences
- Same currency: Eliminates FX risk
- High liquidity: Enables easy entry/exit
- Stable relationship: Historical ratio should show mean reversion
- Similar coupon structure: Reduces cash flow timing differences
Practical Tips
Keep a Ratio Watchlist
Track 3-5 pairs in TradingView. Set alerts at key ratio levels.
Document Your Trades
Record entry ratio, exit ratio, and P&L for each trade. Learn from patterns.
Understand Seasonality
Some ratios have seasonal patterns (tax selling, coupon payments, etc.).
Account for Costs
Commissions and fees can eliminate small ratio profits. Ensure spreads are wide enough.
Common Mistakes to Avoid
Related Resources
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