What it measures
The Sharpe ratio tells you how much return you earned for each unit of risk, where risk means the ups and downs of returns. Two strategies with the same return are not equal if one got there with far wilder swings.
Formula
Sharpe = (annual return - risk-free rate) / annual Standard deviation and volatility
The risk-free rate is usually the yield on short-term Treasury bills. Daily figures are annualised: multiply the average daily excess return by 252 and the daily standard deviation by the square root of 252.
Example
A strategy returns 12% a year with 15% volatility while T-bills pay 4%: (12 - 4) / 15 = 0.53.
Rough guide
| Sharpe | Reading |
|---|---|
| Below 0 | Worse than cash |
| 0 to 0.5 | Weak |
| 0.5 to 1 | Similar to the stock market over the long run |
| 1 to 2 | Strong |
| Above 2 | Exceptional; check for Overfitting in investing |
Limits
- It punishes upside swings as much as downside ones. The Sortino ratio fixes this.
- It assumes returns are roughly bell-shaped; strategies with rare large losses can look safe. See Skewness of returns and Kurtosis and fat tails.
- It does not show the worst loss. Pair it with Maximum drawdown.
Questions
What is a good Sharpe ratio?
For a long-term stock portfolio, above 0.5 is typical of the market, above 1 is strong, and above 2 over many years is rare and worth checking for errors or overfitting.
See also
- Sortino ratio How the Sortino ratio improves on the Sharpe ratio by counting only downside volatility, how to calculate it, and when to prefer it.
- Calmar ratio The Calmar ratio compares annual return with the worst drawdown. How to calculate it, what a good value is, and why drawdown-based risk matters.
- Standard deviation and volatility What volatility means in investing, how standard deviation of returns is calculated and annualised, and typical volatility for stocks, bonds and leveraged funds.
- How to read a backtest Which numbers in a backtest report to trust, which to question, a checklist for spotting unrealistic results, and how to compare a strategy with a benchmark.
Pages that link here: Skewness of returns, What is backtesting?
Last updated September 30, 2026. Education only, not investment advice.