What is the Sharpe ratio
The Sharpe ratio measures how much return a strategy or portfolio earned above a risk-free rate for each unit of volatility it carried.
A higher figure means more excess return for the same amount of ups and downs. A negative figure means the strategy earned less than the risk-free rate over the period.
Ready to try it on a real or demo account?
Partner link · trading carries a high risk of loss
Sharpe ratio formula
Sharpe ratio = (Rp − Rf) / σp
- Rp: the average return of the portfolio or strategy over the period.
- Rf: the risk-free rate for the same period, usually a short-term government bill yield or a policy rate.
- σp: the standard deviation of the excess returns (Rp − Rf), which is the usual measure of volatility.
All inputs must use the same frequency, for example monthly returns with a monthly risk-free rate. To annualise a ratio built from monthly or daily data, multiply it by the square root of the number of periods in a year. See annualized return and annualized volatility.
For a reader in Pakistan, a local benchmark could be the SBP policy rate. The latest decision on record is: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). For a USD-denominated account, a USD risk-free rate fits better. The ratio is only comparable between strategies when they use the same Rf.
Worked example (hypothetical)
This case is hypothetical and has no real figures.
- Strategy A and Strategy B have the same average monthly return over the same months, and both returns are above the risk-free rate.
- A's monthly results swing widely, with large gains and large losses. B's results stay close to its average.
- The top of the formula (Rp − Rf) is the same for both strategies. B's standard deviation is smaller, so B has the higher Sharpe ratio.
- Strategy C has a higher average return than both, but its swings are much larger. Its Sharpe ratio can still be lower than B's.
The ratio answers "return per unit of risk", not "which strategy made the most money".
What is a good Sharpe ratio
There is no universal threshold. A Sharpe ratio is "good" only when you compare it with others:
- the same asset class
- the same period
- the same data frequency
- the same risk-free rate
Rules of thumb in the press ignore these conditions. A high ratio from a short backtest says little about the future. A past Sharpe ratio is not a forecast, and leveraged forex and CFD trading can lose money fast whatever a report shows.
Edge cases for experienced readers
- Non-normal returns. Standard deviation treats upside and downside the same way and misses fat tails. Strategies that sell options or average down can show a high Sharpe until a large loss arrives.
- Smoothed or illiquid prices. These understate volatility and inflate the ratio. Autocorrelated returns break the square-root annualisation.
- Ex-post vs ex-ante. Reports show the realised (ex-post) ratio. The ex-ante version uses expected returns and is an estimate.
- Leverage. In theory, leverage scales return and volatility together and leaves the ratio unchanged. In practice, financing costs and stop-outs change it.
- Alternatives. The Sortino ratio uses only downside deviation. The information ratio uses a benchmark instead of Rf. See also alpha and beta.
Where you see it
- Fund factsheets and annual reports.
- News about hedge fund performance.
- The MetaTrader 5 Strategy Tester report, which lists a Sharpe Ratio next to drawdown and profit factor (see MetaTrader 5).
- Strategy statistics on copy-trading or signal pages.
To judge a strategy's path and not only its averages, read the ratio together with the equity curve and the maximum drawdown. More context is on the risk management page and in the trading glossary.
Frequent questions
Can the Sharpe ratio be negative?
Yes. It is negative when the average return is below the risk-free rate over the period.
Why do two sources show different Sharpe ratios for the same fund?
They may use different periods, data frequency, risk-free rates or annualisation methods.
Does a high Sharpe ratio mean low risk?
No. It means low measured volatility relative to excess return in the past. Tail risk and future losses are not captured.
Is the Sharpe ratio the same as the Sortino ratio?
No. The Sortino ratio divides by downside deviation only. The Sharpe ratio uses total standard deviation.