Sharpe Ratio
Excess return per unit of total volatility — the canonical risk-adjusted return metric.
`Sharpe = (Rₚ − R_f) / σₚ`. The numerator is the portfolio's excess return over the risk-free rate; the denominator is the standard deviation of those excess returns.
Rules of thumb. On annualised basis: <1.0 = suboptimal · 1.0 = acceptable · >2.0 = excellent · >3.0 = possibly data-mined.
Why it matters. Comparing returns *without* adjusting for volatility rewards high-leverage strategies. Sharpe lets you compare a 10% return at 8% vol to a 14% return at 18% vol — the lower-vol strategy is actually the better risk-adjusted pick.
Pitfalls. Assumes returns are normally distributed; tail-heavy strategies (short vol, credit) can post pristine Sharpe ratios and then blow up. Pair Sharpe with max drawdown and tail-risk metrics (Sortino, CVaR) for a realistic view.
See it applied
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