Ulcer Index
The Ulcer Index (UI) is a technical indicator that measures downside risk in terms of both the depth and duration of price declines. The index increases in value as the price moves farther away from a recent high and falls as the price rises to new highs. The indicator is usually calculated over a 14-day period, with the Ulcer Index showing the percentage drawdown a trader can expect from the high over that period.The greater the value of the Ulcer Index, the longer it takes for a stock to get back to the former high. Simply stated, it is designed as one measure of volatility only on the downside.
Definition: The Ulcer Index (UI) is a technical indicator used to measure downside risk in terms of the depth and duration of price declines. It increases as prices move away from recent highs and decreases as prices rise to new highs. Typically calculated over a 14-day period, the Ulcer Index shows the percentage drawdown traders can expect from the peak during that period. The larger the Ulcer Index value, the longer it takes for the stock to return to its original high. In short, it is designed to measure volatility only on the downside.
Origin: The Ulcer Index was introduced by Peter Martin and Byron McCann in 1989 to provide investors with a tool to measure downside risk in their portfolios. The name of the indicator reflects the psychological stress it describes, akin to the pain of an ulcer.
Categories and Characteristics: The Ulcer Index has the following key characteristics:
- Measures downside risk only: Unlike other volatility indicators, UI focuses solely on the risk of price declines.
- Time period: Typically uses a 14-day period but can be adjusted as needed.
- Percentage drawdown: UI shows the expected percentage drawdown from the peak during the period, helping investors assess potential losses.
Specific Cases:
- Suppose a stock drops from a high of $100 to $80 over the past 14 days. The UI would calculate the downside risk during this period, helping investors decide whether to hold onto the stock.
- In portfolio management, UI can be used to compare the downside risk of different assets, optimizing the risk-reward ratio of the portfolio. For example, a portfolio with a high UI value indicates greater downside risk, prompting investors to adjust asset allocation to reduce risk.
Common Questions:
- Does a higher UI value mean higher investment risk? Yes, a higher UI value indicates greater depth and duration of price declines, meaning higher downside risk for investors.
- How does UI differ from other volatility indicators? UI focuses solely on downside risk, whereas other volatility indicators like standard deviation or VIX measure overall volatility, including both upside and downside.
