A risk-adjusted return metric that measures how much excess return you're getting per unit of risk — higher is better.
The Sharpe ratio measures the return of a strategy relative to its volatility. The formula: (return − risk-free rate) / standard deviation of returns. A Sharpe of 1.0 is decent. A Sharpe of 2.0 is very good. A Sharpe of 3.0+ is institutional-grade.
Sharpe matters because it lets you compare strategies on a risk-adjusted basis. A 30% return with 30% volatility has a Sharpe of about 1.0. A 15% return with 5% volatility has a Sharpe of about 3.0. The second strategy is BETTER even though the absolute return is lower — because the second strategy doesn't burn the trader's nervous system.
The weakness of Sharpe is that it punishes BOTH upside and downside volatility equally. A strategy with huge winners and small losers gets penalized for the upside variance. The Sortino ratio (which only punishes downside variance) fixes this.
Real trade example
Renaissance Technologies' Medallion Fund averaged a Sharpe ratio above 2 for over two decades — the highest sustained risk-adjusted return in modern finance history.
Frequently asked about sharpe ratio
What is a sharpe ratio in trading?+
A risk-adjusted return metric that measures how much excess return you're getting per unit of risk — higher is better.
When will I see sharpe ratio used in real trading?+
On every fund manager's pitch deck, every backtest report, and every prop firm scorecard. Sharpe is the institutional gold standard for risk-adjusted performance.
What is the most common mistake traders make with sharpe ratio?+
Treating high return as proof of skill. A 50% annual return at 60% volatility is worse than a 20% return at 8% volatility — even though the absolute number looks more impressive.
What do experienced traders know about sharpe ratio that beginners don't?+
Aim for Sharpe above 1.5 on any strategy you intend to trade live. Below 1.5, the variance is too high relative to the return — you'll quit during normal drawdowns even if the strategy is technically profitable.