Performance Metric

Sharpe Ratio — Definition & Example

Risk-adjusted return — excess return per unit of total volatility.

Sharpe ratio measures how much return a strategy earns per unit of total risk taken (measured as standard deviation of returns). A Sharpe ratio above 1.0 is considered good; above 2.0 is excellent. The metric penalises both upside and downside volatility equally, which is why some traders prefer Sortino ratio (which only penalises downside). Sharpe is the standard institutional measure of risk-adjusted performance.

Formula

Sharpe Ratio = (Rp − Rf) / σp,  where Rp = portfolio return, Rf = risk-free rate, σp = standard deviation of portfolio returns

Example

Strategy returns 18% annually with 12% volatility. Risk-free rate is 6%. Sharpe = (18 − 6) / 12 = 1.0. The strategy earns one unit of excess return per unit of volatility taken.

Sortino Ratio Calmar Ratio Max Drawdown

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Sharpe Ratio — Definition & Example

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