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Sharpe Ratio

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.

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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.

Related terms

Sortino Ratio

advanced

A risk-adjusted return metric similar to Sharpe but only counts downside volatility — better for asymmetric strategies.

Expectancy

advanced

The average dollar (or R) amount you can expect to make per trade over many trades — the math behind whether a strategy works.

Drawdown

intermediate

The peak-to-trough drop in your account equity — a measure of how bad your worst losing streak got.

CAGR (Compound Annual Growth Rate)

intermediate

The annualized rate of return that an investment would have earned if it grew at a steady rate every year — used to compare strategies over time.

R-Multiple

intermediate

A unit that measures profit or loss in multiples of the initial risk taken on a trade — normalizes performance across different position sizes.

Breakeven

beginner

The price at which closing your trade results in zero profit and zero loss — moving your stop here protects you from a loss.

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