Sharpe Ratio |
Investment performance is best described by the Sharpe ratio. Sharpe ratio describes the stability of an investment returns.
The aim of an investment is to generate the maximum average return with the minimum volatility. Sharpe Ratio Example: An investor has to choose between two investments with the equity curves displayed above. Although Investment 2 has a higher ending value than Investment 1, it has much higher volatility and drawdown than Investment 1. As a result, Investment’s 1 Sharpe Ratio is 3 times higher than Investment’s 2 Sharpe Ratio and hence Investment 1 is preferred. Enter your Email below to Download Free Historical Data for Nikkei 225 and Economic Data for 120,000+ Macroeconomic Indicators and Market Data covering Stocks, Bonds, Commodities, Currencies & Financial Indices of 150 countries in Excel or via Quantitative Python API.
Sharpe Ratio Formula The Sharpe ratio is calculated by using the average annualized returns of a strategy adjusted by the risk free interest rate in the number and the annualized volatility in the denominator. Any investment that has a Sharpe ratio of less than 1 is not acceptable. Investments with Sharpe Ratio between 1.5 and 2.0 are excellent investments. Investments achieving profitability every month, the annualized Sharpe ratio is greater than 2. Invesments profitable almost every day, the Sharpe ratio is greater than 3.
Notes: The risk-free rate must be subtracted only for strategies that have financing costs. Intraday Strategies (no overnight positions) and Dollar Neutral Investmentss (Dollar Neutral Portfolios are self-financing that is cash from selling short pays for purchase of long positions) don’t require subtracting the risk-free rate. Long only strategies require subtraction. Annualized Sharpe Ratio |