A technical indicator that measures downside risk, in terms of both depth and duration of price declines. The Ulcer Index (UI) 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 14 days, with the UI showing the percentage drawdown a trader can expect from the high over that period.
The greater the value of the UI, the longer it takes for a stock to get back to the former high.
The indicator is calculated in three steps:
Developed by Peter Marin and Byron McCann in 1987 for analyzing mutual funds, the indicator only looks at downside risk, not overall volatility like standard deviation.
Which price high is used in the UI calculation is determined by adjusting the look back period. A 14-day Ulcer Index measures declines off the highest point in the last 14 days. A 50-day Ulcer index measures declines off the 50-day high. A longer lookback period provides investors with a more accurate representation of the longer term price declines they may face. A shorter-term lookback period provides traders a gauge of recent volatility.
Use the Ulcer Index to compare different investment options. A lower average UI means lower drawdown risk compared to an investment with a higher average UI. Applying a moving average to the UI will show which stocks and funds have lower volatility overall.
Watching for spikes in UI which are beyond "normal" can also be used to indicate times of excessive downside risk, which investors may wish to avoid by exiting long positions.