Finance theory states that “the greater the risk the greater the potential reward". As stated previously, the Ulcer Index believes that it is only downside risk that is important to the risk-averse investor. Therefore, a comparison of stocks, mutual funds, commodities using the Ulcer Index might prove valuable.
A comparison of two stocks in the semiconducter sector is given below, Advanced Micro Devices (AMD) stock on the top and Intel (INTC) stock on the bottom along with their respective Ulcer Indexes:
AMD has a higher Ulcer Index than INTC, therefore, during the space of price information on the chart above, AMD would be viewed as the riskier alternative.
In order to justify investing in AMD as opposed to INTC, AMD potential rewards would vastly have to outweigh INTC potential rewards.
The real strength of the Ulcer Index is its focus on only downside risk. To illustrate, a stock gapping up 10% would affect the standard deviation calculation the same as a stock that gapped down 10%; however, if an investor was long stock, which a vast majority are, the gap up would be viewed with joy, while the gap down would be viewed with horror. While standard deviation has its place and is still useful, the Ulcer Index focuses on downside risk rather than the simple standard deviation/variance calculation that calculates upside and downside risk together.