The Ulcer Index by Gary H. Elsner, Ph.D.
A good risk index can be useful in the selection of stocks,
funds, and trading systems. Here, then, is the ulcer index, why
it is superior to the standard deviation statistic, and how it
can be used in a variety of personal investing or professional
money management applications.
What is risk, and how is it measured?
Risk is commonly defined
in terms of the volatility of
an investment’s total return or
the volatility of the price. The
standard deviation is a good
measure of volatility, since it
measures the amount of variation
around the average and is
probably the most widely used
measure of financial risk. But
the standard deviation has two weaknesses for financial instruments. First, it measures the variation from the average in both
the up (good) direction as well as the down (bad) direction.
Second, the standard deviation does not distinguish between
short or long sequences of losses. Investors are only concerned
about downside risk (or the potential for losses), whereas
upside changes or rapid increases in value create profits.