What is Sharpe Ratio?
Risk-adjusted return — the only honest scoreboard for comparing strategies across instruments and timeframes.
Definition
Sharpe = (R_strategy − R_riskfree) ÷ σ_strategy, where R is annualised mean return and σ is the annualised standard deviation of returns. Quoted as a single number: < 0 = losing money on a risk-adjusted basis, 0–1 = noise/marginal, 1–2 = decent strategy, 2–3 = good, > 3 is rare for sustained out-of-sample performance.
Why it matters for trading
- Raw return lies. A +50% year on a strategy with 60% volatility is worse than +25% on a strategy with 15% vol. Sharpe normalises so the comparison is honest.
- Sharpe regimes shift. A strategy that ran Sharpe 2.0 in 2017-2019 (low vol) might run 0.7 in 2022-2024 (high vol) without anything *operationally* changing — vol-of-PnL increased.
- Sharpe alone is incomplete. A strategy with Sharpe 1.5 and a 40% max drawdown is harder to hold than Sharpe 1.2 with a 12% max drawdown. Combine with drawdown for a complete picture.