Measure the quality of your returns. Discover if your trading profit is truly "skilled" or simply the result of taking excessive risk.
* Risk-Free Rate is usually the yield on 10-Year Government Bonds.
Anyone can get a 50% return by taking extreme risks (gambling). The Sharpe Ratio penalizes volatility, proving that a steady 15% return is often "better" than a volatile 50% return.
Professional Context: A Sharpe Ratio of 1.0 or higher is considered good by most hedge funds. A ratio above 3.0 is considered statistically "exceptional" and very difficult to maintain long-term.
Invented by Nobel laureate William F. Sharpe, this ratio is used by institutional investors to evaluate how much excess return they are receiving for the extra volatility that they endure for holding a risky asset rather than a risk-free asset.
Standard deviation measures how much a stock's return fluctuates from its average. If a stock jumps 20% one month and drops 15% the next, it has high volatility. The Sharpe Ratio penalizes this "bumpy ride," rewarding strategies that provide smooth, consistent growth.
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