The Ulcer Index is a market risk measure or technical analysis indicator. It was developed Peter Martin and Byron McCann. It has been designed as a measure of volatility, but only volatility in the downward direction but the amount of drawdown or retrenchment occurring over a period.
Other volatility measures like standard deviation treat up and down movement equally, but a trader doesn’t mind upward movement. It is always the downside that causes stress and stomach ulcers that the index’s name suggests.
Calculation
The index is based on a given past period of N days. Working from oldest to newest a highest price (highest closing price) seen so-far is maintained, and any close below that is a retrenchment, expressed as a percentage
For example if the high so far is $5.00 then a price of $4.50 is a retrenchment of -10%. The first R is always 0, there being no drawdown from a single price. The quadratic mean (or root mean square) of these values is taken, similar to a standard deviation calculation.
The squares mean it doesn’t matter if the R values are expressed as positives or negatives, both come out as a positive Ulcer Index.
The calculation gives similar results when calculated on weekly prices as it does on daily prices. It is advised 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.
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