Sharpe Ratio
Sharpe ratio = (R_p − R_f) / σ_p, where R_p is portfolio return, R_f is the risk-free rate, and σ_p is the standard deviation of returns over the same period. Annualized Sharpe multiplies the per-period number by sqrt(periods per year). A Sharpe of 1.0 is the rough threshold for a strategy worth running; above 2.0 is rare in real, capacity-meaningful systems.
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Definition
Sharpe ratio
Sharpe ratio = (R_p − R_f) / σ_p, where R_p is portfolio return, R_f is the risk-free rate, and σ_p is the standard deviation of returns over the same period. Annualized Sharpe multiplies the per-period number by sqrt(periods per year). A Sharpe of 1.0 is the rough threshold for a strategy worth running; above 2.0 is rare in real, capacity-meaningful systems.
Why it matters
Sharpe is the lingua franca of strategy comparison. Allocator decks, prime broker reports, and academic papers all quote it. The catch: it assumes returns are roughly Gaussian, which they aren't, and it treats upside volatility the same as downside, which makes it punish strategies that have asymmetric payoff profiles.
How it works
Compute periodic excess returns. Take the mean and standard deviation. Divide. Annualize by sqrt(N). Report the standard error — most reported Sharpe ratios from short backtests have a confidence interval wide enough to include zero.
Example
Equity long-short strategy, 5 years monthly
Mean monthly excess return
0.8%
Monthly return σ
2.1%
Monthly Sharpe
0.38
Annualized Sharpe
0.38 × sqrt(12) = 1.32
Sharpe 1.32 over 60 monthly observations has a standard error around 0.46 — the 95% CI spans 0.4 to 2.2. Quote the point estimate alone and you're hiding the noise.
Key Takeaways
Sharpe penalizes upside volatility identically to downside — Sortino fixes this.
Short-sample Sharpe ratios have wide confidence intervals; the point estimate alone overstates conviction.
Strategies with skewed or fat-tailed returns are under-described by Sharpe.
Related Terms
Try These Tools
Run the numbers next
Sharpe vs Sortino Calculator
Paste daily returns; get Sharpe, Sortino, Calmar, and Omega side-by-side with a recommendation on which ratio fits your distribution.
Deflated Sharpe Ratio Calculator
Bailey & López de Prado deflated Sharpe — corrects observed Sharpe for selection bias across K trials. Reports deflated Sharpe, PSR (probability of skill).
Risk-Adjusted Returns Calculator
Paste a returns CSV. Sharpe, Sortino, Calmar, Omega, alpha, beta, tracking error, information ratio, max drawdown, and tail moments — plus.
FAQ
Questions people ask next
The short answers readers usually want after the first pass.
Sources & References
- Mutual Fund Performance — Journal of Business (Sharpe, 1966)
Related Content
Keep the topic connected
Sortino Ratio
Sortino ratio: same numerator as Sharpe, denominator only counts downside volatility. When it's the right number to look at.
How to use Deflated Sharpe Ratio Calculator
Deflated Sharpe Ratio: observed Sharpe, sample length, K trials in. Returns Bailey-Lopez de Prado deflated Sharpe and PSR (probability of skill).