What Is the Sharpe Ratio? Reward per Unit of Risk

The Sharpe ratio asks not just how much you made, but how smoothly. It divides your average return by its standard deviation — the total volatility of your results — so consistent gains score higher than the same gains earned through stomach-churning swings.

Sharpe ≈ average return ÷ standard deviation of returns

Why it matters

Return alone can flatter a reckless system. Two traders both finish +20R for the year, but if one did it in a calm, steady climb and the other through violent ups and downs, the steady one has the higher Sharpe — and the more repeatable, sizable edge. Risk-adjusted return is what tells them apart.

How to read it

• Higher is better — more reward for each unit of volatility you endure.
• It punishes all volatility — Sharpe treats big upside swings as "risk" too. If that feels unfair, the Sortino ratio penalises only downside moves.
• Context matters — compare your own Sharpe over time rather than chasing a universal "good" number; the exact value depends on how it is calculated and over what period.

How to use it

• Track the trend — a rising Sharpe means your results are getting smoother relative to their size.
• Read it with max drawdown — Sharpe describes the bumpiness of the ride; drawdown describes the worst single fall.