The Ulcer Index measures the "stress" of holding a trade or investment by measuring price retracements. The Ulcer Index is based on the notion that downward volatility is bad, but upward volatility is good.
Unlike standard deviation, the financial industry's benchmark way of measuring the risk of a stock, which equally weights both violent increases to the upside (upside volatility) and violent decreases to the downside (downside volatility), the Ulcer Index takes a more enlightened approach that states that investors only care about the downside risk of a stock, not the upside risk (upside risk is good, it is equivalent to profits. . . if you are long stock, that is).
The chart of Intel stock below shows various elements of the Ulcer Index:
Measuring Drawdowns
On the very left of the chart, Intel stock had a strong, sustained movement higher, marked by the long string of green, bullish candlesticks. Notice that the Ulcer Index remained flat, well below the safe level.
- Above safe level (>5): Many downward retracements, investment will cause the investor ulcers, stress, and/or difficult nights sleeping.
- Below safe level (<5): A moderate to low number of price retracements to the downside; relatively few ulcers, stress, and/or difficult nights sleeping.
A third of the chart from the left, there was a 14-day drawdown period; this drawdown period was seen with the sharp increase in the Ulcer Index. Once the price of Intel was making new highs past the drawdown period, the Ulcer Index fell.
The high price of Intel on the chart was marked by a large gap downward; the Ulcer reacted sharply to this drawdown, rising above the safe level.
Another use for the Ulcer Index is shown on the next page: Comparing Investments using the Ulcer Index.
