Sharpe ratio
Return earned per unit of volatility endured.
It subtracts the risk-free rate from your return and divides by volatility, answering: were you rewarded for the bumpiness, or just bumped about? Above 1 is generally considered good.
It punishes upside volatility exactly as harshly as downside, which is strange: nobody complains about unexpected gains. It can also be gamed by strategies that produce small steady profits and rare catastrophic losses, which look wonderful right up until they do not.
Sharpe = (Return − Risk-free rate) ÷ Standard deviationVolatile is not the same as risky
The jumpy line ends higher. The calm one quietly walks to zero. Volatility is what you feel; risk is what actually takes your money.
It is the standard way to compare strategies that took different amounts of risk.
Trusting a high Sharpe from a strategy that sells insurance against rare disasters. The disaster has simply not happened yet.
Related terms
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