Sharpe Ratio
Risk Management
What it means
A number that measures return earned per unit of risk taken. Above 1 is good, above 2 is excellent, and below 0 means you are losing money.
Example
A strategy returning 20% a year with 10% annual volatility has a Sharpe of about 2.0 (after adjusting for the risk-free rate). Another returning 20% with 30% volatility has a Sharpe of about 0.67 -- worse risk-adjusted.
Mistake beginners make
Beginners compare strategies by raw return only. A 30% return with a 0.4 Sharpe is far worse than a 20% return with a 1.8 Sharpe -- the first is taking dangerous risk for the same dollars.
Related terms
- Expectancy — The average amount you expect to make per trade, accounting for both wins and losses. A po…
- Volatility — How much and how fast an asset price swings. High volatility means large price moves in sh…