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Ulcer Index

In 1987 Peter Martin and Byron McCann developed the Ulcer Index. The Ulcer Index is a volatility indicator used to measure downside risk potential. Originally designed for mutual funds the name given; Ulcer implies how much downside investors can expect to stomach on the pertaining stock.

 

The Ulcer Index measures volatility based on price depreciation from its high over a certain look-back period. The index is zero only if prices close higher each period. This indicates no downside risk because prices are rising. Stocks don't go straight up so there will be declines along the way. Using a default setting of 14 periods, the Ulcer Index reflects the expected percentage drawdown over this period.

"Ulcer Index measures the depth and duration of percentage drawdowns in price from earlier highs. The greater a drawdown in value, and the longer it takes to recover to earlier highs, the higher the UI. Technically, it is the square root of the mean of the squared percentage drawdowns in value. The squaring effect penalizes large drawdowns proportionately more than small drawdowns."

 

  - Peter Martin

 

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Ulcer Index is calculated using the following formulae:

 

% Drawdown = ((Close - 14-period Max Close)/14-period Max Close) x 100

 

Squared Average = (14-perod Sum of % Drawdown Squared)/14

 

Ulcer Index = Square Root of Squared Average

 

The Ulcer Index measures risk by focusing on pullbacks represented by price declines. This indicator is best suited for long term investors or traders. The index wavers around zero when prices regularly record higher highs. The index rises when prices move lower and extend from their recent high. Keep in mind that the Ulcer Index is not an indicator as such. It's more of a way measure of downside risk used to compute risk-adjusted returns.

 

As with all other indicators, don't just rely on the defaults, adjust your indicators to suit the stock you are looking at and your trading style.

Typically shorter look backs (lower #'s on your indicators) give you quicker signals which is good for aggressive traders, while longer look backs (higher #'s on your indicators) give slower but more reliable signals for traders who are more conservative.

 

As we always say: "Don't use your hard earned cash to find out what kind of trader you are, use a virtual account for that."

Links for free virtual trading sites can be found on our Resources page: