What is the Ulcer Index and why is it important?

The Ulcer Index is a financial risk measure that focuses on downside volatility. Unlike standard deviation (volatility), which treats price increases and decreases equally, the Ulcer Index only measures the depth and duration of drawdowns from previous peaks.

It was developed by Peter Martin and Byron McCann in 1987. The name "ulcer" was chosen to reflect the stress and anxiety an investor feels when their portfolio is losing value.

Why is it different and useful?

Most investors do not perceive price increases as "risk." The real pain is felt during the downturns. The Ulcer Index captures this feeling in a way that standard volatility cannot.

It measures two things:

1. The depth of the fall: How much has the value dropped from its last high?
2. The duration of the fall: How long does the value remain below its previous high?

A high Ulcer Index indicates that the investment has experienced deep and prolonged drawdowns, which would have been stressful for an investor. A low index suggests that the drawdowns have been mild and short-lived.

How is it calculated?

The calculation is a bit more complex than other metrics, but conceptually it involves:

1. Calculating the percentage drawdown (% Drawdown) from the previous high for each period.
2. Squaring these drawdowns to penalize large drops more than small ones.
3. Averaging these squared values.
4. Calculating the square root of the average to get the final index.

Interpretation

The Ulcer Index is a number that, by itself, does not have an absolute meaning. Its true power lies in comparison:

• An investment strategy with an Ulcer Index of 5 is preferable to one with an index of 15, as it has been "less painful" to hold.
• It is especially useful for conservative or risk-averse investors, as it helps them choose portfolios that minimize the stress of losses.

On our platform, we provide you with the Ulcer Index as a key metric so you can evaluate not only the performance and volatility of a portfolio, but also the "emotional cost" that would have been involved in holding that investment over time.