Sharpe ratio

A measure of return earned per unit of risk (volatility), a way to compare strategies on reward relative to the bumpiness of the ride.

Also called: risk-adjusted return

The Sharpe ratio divides a strategy's return, above the yield on cash, by its volatility. It answers a fairer question than raw return alone: how much reward did an investor earn for each unit of risk taken along the way?

A higher Sharpe means steadier returns for a given result, or a stronger result for the same swings. Like any single number it can mislead: it treats upside and downside volatility alike. That is why it is read next to drawdown and other measures, never on its own.

Related terms

VolatilityHow much an asset's price fluctuates over time. High volatility means larger swings. It measures turbulence, not direction, and it is not the same thing as risk.
DrawdownThe decline from an investment's most recent peak to its subsequent trough, in percent. It is a direct measure of pain endured, and of the gain needed to recover.
Total returnThe full return of an investment including both price change and income (dividends or interest) reinvested. It is the honest measure of what an investor actually earned.