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<HTML><HEAD><TITLE>The Ulcer Index - April 1999</TITLE>
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<DIV>Perhaps their book will contain more details.</DIV>
<DIV><BR>Regards,<BR>Ton Maas<BR><A
href="mailto:ms-irb@xxxxxxxxxxxxx";>ms-irb@xxxxxxxxxxxxx</A><BR>Dismiss the
".nospam" bit (including the dot) when replying.</DIV>
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<BLOCKQUOTE>
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<HR noShade SIZE=1>
<B><FONT size=+1>MUTUAL FUNDS
<HR>
</FONT><FONT size=+4>The Ulcer Index
<HR>
</FONT><I>by Gary H. Elsner, Ph.D.
<HR>
</I></B><I><FONT size=+1>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. </FONT></I>
<HR>
</CENTER><FONT size=+2>W</FONT>hat 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.
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<BLOCKQUOTE>
<BLOCKQUOTE><B>FIGURE 1: FIDELITY EMERGING MARKET. </B>The
ulcer index uses only the retracements from the price peaks
(the shaded areas) in the
calculation.</BLOCKQUOTE></BLOCKQUOTE>The standard deviation may
still be the most widely used because it has been around longer
than other risk indices and most computer programs have the
capability of calculating it. However, there is another measure of
risk, superior to the standard deviation: the ulcer index.
<P>Peter G. Martin and Byron B. McCann are credited with the
creation of the ulcer index. They describe it in their 1989 book,
<I>The Investor's Guide To Fidelity Funds</I>. (To see the
calculation for the ulcer index, see the sidebar "The ulcer
index.") In contrast to the standard deviation, the ulcer index
has none of the aforementioned weaknesses since it calculates
retracement, which is the tendency for values to fall from
previous highs, by measuring the depth of the drop and the time
that it takes the performance measure to recover to the original
level.
<P>Another advantage is that the ulcer index doesn't measure
downside changes from the average but from the previous high. For
example, in Figure 1, all of the shaded areas are included in the
calculation of the ulcer index. The measurement includes every
drop in performance in the period being studied. Funds or trading
systems with high ulcer index readings should be avoided unless
they have such exceptionally high returns that the risks are
justified. In addition, dividing returns by the ulcer index
produces a useful risk-adjusted return measurement.</P></BLOCKQUOTE>
<CENTER>
<HR width="100%">
<I>Gary Elsner, Ph.D., is editor of the mutual fund timing
newsletter </I>Achieve <I>Profits (Website
http://www.AchieveProfits.com). He may be reached via E-mail at
gelsner@xxxxxxxxxxxxxxxxxxx</I></CENTER>
<BLOCKQUOTE>
<CENTER>
<H5><I>Excerpted from an article originally published in the April
1999 issue of Technical Analysis of STOCKS & COMMODITIES
magazine. All rights reserved. © Copyright 1999, Technical
Analysis, Inc.</I></H5></CENTER></BLOCKQUOTE>
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