What Does the Ulcer Index Mean?
A technical indicator called the Ulcer Index (UI) gauges downside risk by looking at the length and depth of price falls. The value of the index rises as the price moves away from a previous high and decreases when the price climbs to new highs. The Ulcer Index, typically measured over 14 days, indicates the percentage drop a trader may anticipate from the peak.
The longer it takes for a stock to return to its previous high, the higher the value of the ulcer index. In short, its purpose is to serve as a single indicator of just negative volatility.
Knowing the Ulcer Index (UI)
In 1987, Peter Marin and Byron McCann created the Ulcer Index to analyze mutual funds. Marin and McCann first published them in The Investor’s Guide to Fidelity Funds in 1989. The indicator ignores overall volatility and solely considers downside risk. While a trader usually does not mind upward movement, other volatility measures, such as the standard deviation, regard up and down movement equally. As the name of the index implies, the downside may lead to stress and stomach ulcers.
How to Determine the Ulcer Index
Three stages are used to compute the indicator:
- [(Close – 14-period High Close)/14-period High Close] is the percentage drawdown. 100 times
- Squared Average = (Sum of Percentage Drawdown Squared over 14 Periods)/14
- The square root of the squared average equals the ulcer index.
One way to select which price to utilize in the ulcer index computation is to change the look-back time. A 14-day ulcer index calculates drops from the 14-day peak point. Declines from the 50-day peak are measured using a 50-day ulcer index. An extended look-back time offers investors a more realistic picture of potential long-term price reductions. A look-back time with a shorter duration gives traders an indication of recent volatility.
The ulcer index is used.
Martin suggests the ulcer index as a risk indicator in several situations where the standard deviation is often used. Additionally, the ulcer index may be plotted over time and used as a technical analysis indicator to compare volatility across various companies or to identify whether stocks are approaching the ulcer-forming zone.
The Ulcer Index is helpful for investors to evaluate various investment possibilities. A lower average ulcer index indicates a lesser drawdown risk than an investment with a higher average UI. The Ulcer Index’s moving average may be used to determine which stocks and ETFs have generally less volatility.
It is also possible to identify periods of significant downside risk by looking for spikes in the ulcer index that are beyond “normal.” Investors should avoid these periods by closing long-term holdings.
