The ulcer index is a stock marketrisk measure or technical analysis indicator devised by Peter Martin in 1987, and published by him and Byron McCann in their 1989 book The Investors Guide to Fidelity Funds. It is designed as a measure of volatility, but only volatility in the downward direction, i.e. the amount of drawdown or retracement occurring over a period. Other volatility measures like standard deviation treat up and down movement equally, but most market traders are long and so welcome upward movement in prices, it is the downside that causes stress and stomach ulcers that the index's name suggests. The term ulcer index has also been used by Steve Shellans, editor and publisher of MoniResearch Newsletter for a different calculation, also based on the ulcer-causing potential of drawdowns. Shellans' index is not described in this article.
Calculation
The index is based on a given past period of N days. Working from oldest to newest a highest price seen so-far is maintained, and any close below that is a retracement, expressed as a percentage For example, if the high so far is $5.00 then a price of $4.50 is a retracement of −10%. The first R is always 0, there being no drawdown from a single price. The quadratic mean of these values is taken, similar to a standard deviation calculation. The squares mean it does not matter if the R values are expressed as positives or negatives, both come out as a positive Ulcer Index. The calculation is relatively immune to the sampling rate used. It gives similar results when calculated on weekly prices as it does on daily prices. Martin advises against sampling less often than weekly though, since for instance with quarterly prices a fall and recovery could take place entirely within such a period and thereby not appear in the index.
Usage
Martin recommends his index as a measure of risk in various contexts where usually the standard deviation is used for that purpose. For example, the Sharpe ratio, which rates an investment's excess return against risk, is The ulcer index can replace the SD to make an ulcer performance index or Martin ratio, In both cases, annualized rates of return would be used. The index can also be charted over time and used as a kind of technical analysis indicator, to show stocks going into ulcer-forming territory, or to compare volatility in different stocks. As with the Sharpe Ratio, a higher value of UPI is better than a lower value.
