Last Updated on 7 September, 2021 by Samuelsson
Backtesting shows that the internal bar strength indicator (IBS) has worked remarkably well for most of the last two decades or more. The reason is most likely the fact that the stock market has been highly mean-reverting during this period.
What is the internal bar strength indicator (IBS)?
IBS is a mean-reverting indicator that compares the current close to the period’s price range. The indicator oscillates from zero to one, as it measures the relative position of the closing price relative to the High and Low.
The formula for IBS is as follows:
So, if the close, high, and low are 9, 10, and 1 respectively, the IBS would be 0.89. If the close is 2 and the high and low stays the same, the IBS would be 0.11.
Over the short term, a low internal bar strength value is considered a bullish signal, while a high value is considered a bearish signal. Thus, the IBS is simply an indicator that helps you to buy on weakness and sell on strength, which is the basis of any mean-reverting strategy. However, this presumes that the market is mean-reverting.
The backtesting result of the internal bar strength indicator
Being a very simplistic indicator, IBS is very easy to code into an algo trading system.
Using Amibroker, the code is as follows:
Buy= IBS<0.2 ;
buyPrice=C ; //buy on the close
Sell= IBS>0.8 ;
sellPrice=C ; //sell on the close
Basically, it means to buy on close if IBS is lower than 0.2 and sell on any day later when the IBS closes above 0.8. It’s just that simple, but it yielded an excellent result on the SPY ETF from 2000 until October 2020. Assuming $100, 000 invested in 2000 and 100% exposure of equity since then, the equity curve looks like this (compounded):
Here are the compounded results:
- Number of trades: 600
- Average gain per trade: 0.41%
- Win-ratio: 69.7%
- Number of days per trade: 4.35
- Average gain winners: 1.32%
- Average loss losers: -1.67%
- Profit factor: 1.92
- Max % drawdown: -26.1%
However, checking the results year by year, you could see that 2018 was a pretty poor year, while 2020 was the best year ever.
The drawbacks of the internal bar strength indicator
One of the main drawbacks is that the indicator does not work in all markets. The IBS more or less works only on individual stocks and stock indices, especially ones that have a broad selection of different industries.
Further testing showed that using the IBS strategy to trade commodity stocks yielded poor returns, which is why the strategy doesn’t work well on Norwegian and Australian stocks/indices, as both countries are heavily dependent on commodity prices. The strategy simply doesn’t work well for gold and metal stocks.
Another weakness is the need to enter on the close. There’s no way to know the close until after the fact. So the trader needs to enter just seconds before the close or after the close in the after-hours, which may be difficult unless he is using automatic systems via your computer or VPS.
Delaying the execution to the open of the next day significantly reduces the returns from the average gain per trade of 0.41% to 0.31%.