What Is the Sharpe Ratio in Trading?

The Sharpe ratio measures how much return a strategy earns for each unit of volatility it takes on.

Formula

Sharpe ratio = (Average return − Risk-free rate) ÷ Standard deviation of returns

It is usually calculated from daily or monthly returns and annualized.

What is a good Sharpe ratio?

As a rough guide, above 1 is considered good and above 2 very good. Very high values over short periods are often unreliable.

Limits for traders

The Sharpe ratio treats upside and downside volatility the same and assumes returns are roughly normally distributed. Many active traders look at it alongside maximum drawdown, profit factor and expectancy.

Related: drawdown, profit factor, 10 metrics every trader should track. See the trading glossary.