Glossary
Sharpe ratio
A measure of risk-adjusted return: how much excess return over the risk-free rate a portfolio earned for each unit of volatility it carried.
On this page
The Sharpe ratio tells you how much return an investment delivered above a risk-free benchmark for every unit of volatility it carried. Economist William F. Sharpe introduced it in 1966 as the "reward-to-variability" ratio. It matters because raw returns hide risk: a fund that gained 12% with wild swings may have done a worse job than one that gained 9% smoothly.
How it works
All three inputs must cover the same period and be annualized the same way. Monthly returns are usually annualized by multiplying the mean by 12 and the standard deviation by √12.
Limits to know
The ratio treats upside and downside swings as equally bad, which is why some analysts prefer the Sortino ratio, which counts only downside deviation. It assumes returns are roughly bell-shaped, so strategies that earn small steady gains and then suffer rare large losses (selling deep out-of-the-money options, for example) can post a flattering Sharpe ratio right up to the blow-up. It is also sensitive to the period chosen: a calm three-year window can make almost anything look efficient. Compare Sharpe ratios only across similar strategies measured over the same dates.