Daily IBS effect in major indices | How to use the IBS indicator

#IBS #backtesting #meanreversion #howtoindicator

The IBS indicator is one of the best mean reversion indicators that actually carries significant predictive power. In this article, Billerikay carried out analysis over a basket of global equity ETFs to show the prominent mean-reverting property of global equity. We also included a possible trading strategy that exploits this property. Make sure you read this article until the end.

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The powerful IBS indicator

IBS's full name is internal bar strength. The maximum value of IBS is 1, and the minimum value is 0. The calculation of IBS is as follow.

IBS = (close - low)/ (high - low)

IBS is a mean reversion indicator. A low IBS value indicates a high likelihood that the next bar would generate a positive return, vice versa. Such a simple indicator is convenient when trading equity indices.

Mean Reverting property in Global equity

To demonstrate the mean-reverting property of equity markets, Billerikay analyzed the average daily return of major equity markets over the past 10 years (2010-2021). We divided the value of IBS into four brackets and calculated the average next-day return accordingly. The results can be found in the image below. We also colour-coated positive returns with green colour and negative returns with red colour for better visualization.

We can observe that for most equity markets, a lower IBS value, i.e., 0-0.25 is associated with a positive next day return (green day) while a higher IBS value, i.e., 0.75-1 is associated with a negative next day return (red day). In plain English, over the last 10 years, a lower IBS gave us a buy signal while a high IBS value gave us a sell signal.

Simple IBS strategy

#backtesting

Now that we understand most markets are responsive to the IBS indicator. We will now show a simple trading strategy using our results.

We tested an IBS strategy on QQQ with the following entry rules using #Amibroker.

1. if IBS < 0.25 Buy on the Close

2. if IBS > 0.75 Sell on the Close

Here is the result.

Win Ratio: 64.86 %

Average Profit % : 1.35%

Averageg Loss % : -1.70%

Profit Factor: 1.49

Sharpe Ratio: 0.76

Calmar Ratio: 0.28

Annual Return: 9.12%

This simple strategy performed extremely well in the COVID shock with a return of 84%. Billerikay believes that tuning the strategy a bit should produce a better result.

Conclusion

Mean reverting phenomenon is common among equity markets around the globe. We demonstrated how to use the IBS indicator to trade equity ETFs in the article. Let us know your thoughts and share with us your trading success!

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Bonus

Check out our MACD strategy

https://www.billerikay.com/post/copy-of-strategy-review-how-to-use-the-macd-indicator

IBS strategy's code in Amibroker.

IBS = (Close - Low)/(High-Low);

Buy = IBS < 0.25;
Sell = IBS > 0.75;

Reference

A. S. Pagonidis, "The IBS Effect: Mean Reversion in Equity ETFs," National Association of Active Investment Managers, 2013.

Disclaimers

We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.