🛡️ Risk & Money·advanced

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.

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.

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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