Mutual Funds  |  APR 1999

The Ulcer Index by Gary H. Elsner, Ph.D.

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.

by Gary H. Elsner, Ph.D.