The Internal Bar Strength indicator (IBS) has worked remarkably well for over two decades. We can only guess why, but the stock market has been highly mean-reverting during this period, and this has, of course, given the IBS a nice tailwind.
IBS is simply an indicator where you buy on weakness and sell on strength, the cornerstone of any mean-reverting strategy. It oscillates from zero to one and measures the relative position of the closing price relative to the High and Low. A low internal bar strength value is supposed to be bullish, and a high value is bearish (for the short-term). The assumption is that the market is mean-reverting. We make some examples of internal bar strength strategies.
Short summary of the Internal Bar Strength (IBS) indicator:
This article explains the Internal Bar Strength Indicator and internal bar strength strategy. We test it empirically (backtest) and explain which markets you will most likely succeed in.
The conclusion is that the Internal Bar Strength Indicator has worked remarkably well over the last 30 years on stocks and stock indices, less so on other asset classes. Last, we backtest some trading strategies based on the IBS indicator.
Is this likely to continue? The indicator made a spectacular comeback in 2019 and 2020 after 2018 produced the first negative return in this century. The increased volatility following the unprecedented Covid-19 lockdowns has made 2020 the best year on record.
If you find this article useful, you might want to have a look at our landing pages for a lot of other trading strategies and edges:
The Internal Bar Strength formula
The formula for IBS is as follows:
Let’s illustrate with an example from the 28th of October 2020: SPY, the ETF of the S&P 500, had a high of 338.25, a low of 326.13, and closed at 326.66. Thus, the IBS that day would be calculated like this:
(326.66 – 326.13)/(338.25 – 326.13) = 0.043
This was a bad day for stocks, where SPY opened significantly down and continued falling throughout the day. The low value of the IBS indicates a good setup for a mean reversion trade. As it turned out, the next day, the 29th of October, ended as a positive day.
Internal Bar Strength (IBS) video
We present three different IBS strategies in this video.
Internal Bar Strength quantified (trading strategies)
Many financial commentators have written about the coming demise and reduced strength of the IBS, recently as late as 2018, after many months of weak performance. As with most things in the financial markets, all good things must come to an end, and IBS performed poorly in 2017 and 2018.
IBS is a very simplistic indicator and widely used by algos, perhaps indicating the good times are over. The markets are flooded with capital, brains, and computing power, and the most popular indicators and strategies will be “arbed” away when they get widely used.
The best strategies can be found in our….
Backtested trading strategies
On this blog we have several times used IBS together with other indicators. However, I have never looked at IBS solely on its own, and this article has a short look at how IBS has performed on the S&P 500 and Nasdaq. Let’s backtest an IBS strategy:
Let’s first start with the S&P 500 by using the ETF SPY. The criteria are simple (using Amibroker):
Buy= IBS<0.2 ;
buyPrice=C ; //buy on the close
Sell= IBS>0.8 ;
sellPrice=C ; //sell on the close
We buy on close if IBS is lower than 0.2, and we sell any day later when the IBS closes above 0.8. An incredible simple IBS strategy and IBS trade!
Despite its simplicity, it has yielded excellent results from 2000 until October 2020 (assuming 100 000 invested in 2000 and 100% exposure of equity since then – i.e. compounded results):
|Average gain per trade||0.41%|
|#days per trade||4.35|
|Average gain winners||1.32%|
|Average loss losers||-1.67%|
|Max % drawdown||-26.1%|
The equity curve looks like this (compounded):
2018 was a pretty poor year for the IBS strategy, but it made a huge comeback so far in 2020, the best year ever:
The IBS has worked even better on Nasdaq (QQQ – compounded):
Let’s make a twist to the Internal Bar Strength Indicator (IBS) strategy
Let’s change the IBS strategy somewhat but still use the IBS as the only indicator for both the entry and the exit, and we get the following equity curve from 1993 until today:
The strategy produced a CAGR of 15.5% while being invested only 36% of the time. There are 526 trades, the average trade lasts 5.9 trading days, 74%, the average win is 1.67%, the average loser is 1.75%, the max drawdown is 22%, the profit factor is 2.73, and the Sharpe Ratio is 2.
Would you like to know the code and the criteria? You get the code for Amibroker/Tradestation and in plain English. You can order the strategy by clicking the links below or subscribing to our Trading Edges. You can order the strategy on this link (IBS Strategy no. 2):
When you have paid, please press the link below to access the code (PDF file):
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The Internal Bar Strength indicator works best in bear markets
Perhaps ironically, the strategy seems to perform the best in bear markets. The reason is most likely that the biggest up days happen in bear markets.
Yes, you heard it right: the biggest up days happen during bear markets, perhaps contrary to common sense. You can read more in our blog post about the anatomy of a bear market.
For example, from the top in May 2008 to the bottom in early March 2009 (the GFC), S&P 500 lost about 50% of its value, but there were 99 up days and 104 down days during this period. During the same period, it was 51 days with daily rises (from close to close) higher than 1% and 30 days with daily rises above 2%. You can read more about these data in this article.
I suspect that short covering is one of the main reasons we see these enormous spikes during bear markets. Bear markets are shorter in duration than bull markets, and increased uncertainty makes the markets much more volatile. Bull markets are sedate: the daily volatility is significantly lower.
Does adding a filter only to take signals during volatile times pay off?
We can, for example, add a volatility filter like VIX: buy only when VIX closes above a moving average of x days. If we use a VIX filter where we require VIX to close above its 100-day average, the average gain per trade in SPY increases from 0.41% to 0.53% while the profit factor goes from 1.92 to 2.19.
However, be careful adding this filter because an optimization reveals the result is pretty variable from even small changes in the number of days of the moving average.
By tweaking a little, it seems the IBS works best as long it’s not too overbought compared to the 200-day moving average. If the close of SPY is max 5% above the 200-day moving average, it improves the result the best:
Buy= IBS<0.2 AND C<(MA(C,200)*1.05);
The average gain is 0.53% and the profit factor is 2.23. However, be careful as the risk of curve fitting is high. However, it shows that you can employ the IBS indicator systematically and successfully.
Combining the Internal Bar Strength indicator with other indicators
The numbers below show how you improve the results by combining two indicators in a twist to the trading strategies we did above. This table illustrates the results for SPY:
|Average gain per trade||0.76%|
|#days per trade||4.98|
|Average gain winners||1.77%|
|Average loss losers||-2.33%|
|Max % drawdown||-23.75%|
For QQQ the results are much better:
|Average gain per trade||1.36%|
|#days per trade||4.82|
|Average gain winners||2.5%|
|Average loss losers||-2.18%|
|Max % drawdown||-19.5%|
The equity curve compounded for QQQ looks impressive (logarithmic chart):
The overlap in trades between SPY and QQQ is of course very high and thus it doesn’t make sense to trade both, in our opinion.
Would you like to know the code and the criteria? You can order the strategy by clicking the links below or subscribing to our Trading Edges. You can order the strategy on this link (please choose “IBS + second indicator” product – you get the code in Amibroker/Tradestation and plain English):
When you have paid, please press the link below to access the code (PDF file):
Alternatively, you can subscribe to our Trading Edges where we send out ideas like this monthly for a much lower fee per edge. The edge above will be presented as an edge in a few months. If you’d like to receive similar ideas, please subscribe to our Trading Edges:
Does the Internal Bar Strength indicator work in any market?
Unfortunately, it doesn’t. The IBS more or less only works on single stocks and stock indices. Furthermore, it works best on indices that have a broad selection of different industries.
Some parts of the stock population produce poor returns using the IBS: commodity stocks for example.
Hence, IBS doesn’t work well on Norwegian and Australian stocks/indices, as both countries depend heavily on commodity prices. Likewise, you will be hugely disappointed if you try IBS on gold and metal stocks. It simply doesn’t work.
Does this mean we should skip the indicator, assuming a robust indicator should work on all asset classes?
No. It’s naive to believe that any indicator works on all asset classes. Every market has its own “rules” and ecology where you, as a trader, must adapt to the current and local environment.
Just as a Norwegian investor can’t expect to find the same temperament and mentality in Nigeria as in Norway, you, as a trader, must adapt to the market you are trading in. There are no universal rules across the asset classes.
That’s perhaps disappointing to many, but on the other hand, it serves you opportunities if you are willing to adapt and do proper research.
The weakness of the Internal Bar Strength indicator is execution:
One weakness of the strategy is the need to enter on the close. Obviously, you don’t know the close until after the fact, meaning you need to enter just seconds before or after the close in the after hours. This is a hassle unless you trade automatic systems via your computer or VPS.
The importance of getting the closing price is paramount. If you delay the execution to the open the day after the signal, the return falls significantly: for S&P 500 the average gain per trade falls from 0.41% to 0.31%. All important parameters worsen, also for QQQ.
Concluding remarks about the IBS:
The IBS indicator still seems to work pretty well. However, it performs best under conditions where uncertainty makes the stock markets volatile. Furthermore, it’s one of the easiest formulas to compute.
We use IBS in our own swing trading, but always together with some other indicator or factors.
Furthermore, don’t expect the indicator to work in any market: it only works on stocks in certain industries and stock indices with a broad base of different sectors/industries.
We believe you can develop a profitable IBS strategy if you use some of the hints in this article.
Can the strategy be improved?
We are not oracles, and we are sure some traders can improve the strategy. Do you have any ideas on how to improve it?
If so, please comment below or drop us an e-mail.