# Sharpe ratio

> The Sharpe ratio is excess return divided by volatility: subtract the risk-free rate from a strategy’s return and divide by the standard deviation of those returns. It answers how much compensation the strategy delivered per unit of risk taken. Above 1.0 is generally considered good and above 2.0 excellent, but the figure is only comparable between strategies measured over the same period at the same frequency.

Canonical HTML page: https://qanterion.com/glossary/sharpe-ratio
Updated: 2026-08-18
Also known as: risk-adjusted return, reward-to-variability ratio

## How it is calculated

```
Sharpe = (Return − Risk-free rate) ÷ Standard deviation of returns

Annualise by scaling: Sharpe_annual = Sharpe_period × √(periods per year)
Sortino replaces the denominator with downside deviation only.
```

## Worked example

18% return, 4% risk-free rate, 12% volatility → (18 − 4) ÷ 12 = 1.17.

## It penalises upside as well as downside

Standard deviation treats a large gain and a large loss identically, so a strategy with occasional big winners is scored the same as one with occasional big losers. The Sortino ratio exists for this reason: it uses downside deviation only. For strategies with deliberately skewed payoffs — trend following, long options — Sharpe systematically understates quality.

## Sampling frequency changes the answer

A Sharpe computed on daily returns and annualised by √252 is not the same statistic as one computed on monthly returns annualised by √12, and serial correlation in returns makes the higher-frequency version optimistic. When comparing published figures, the frequency and the annualisation convention matter as much as the value.

## How it gets misread

A high Sharpe is routinely read as a low-risk strategy. It is a smoothness measure, not a survival measure: a strategy selling tail risk shows an excellent Sharpe right up to the event that ends it. Read Sharpe next to maximum drawdown, never instead of it.

## Calculate it

- Sharpe ratio calculator: https://qanterion.com/tools/sharpe-ratio-calculator
- Compound Growth Calculator: https://qanterion.com/tools/compound-growth-calculator

## See also

- Maximum drawdown: https://qanterion.com/glossary/max-drawdown
- Expectancy: https://qanterion.com/glossary/expectancy
- Overfitting: https://qanterion.com/glossary/overfitting

## Sources

- [The Sharpe Ratio](https://web.stanford.edu/~wfsharpe/art/sr/sr.htm) — The Journal of Portfolio Management (author's reprint, Stanford University)
- [The Deflated Sharpe Ratio](https://www.davidhbailey.com/dhbpapers/deflated-sharpe.pdf) — The Journal of Portfolio Management (author copy, David H. Bailey)

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## Risk notice

Definitions are educational. Nothing here is investment advice, and no metric described on this page predicts future results.