What is the Sharpe ratio?
The Sharpe ratio, developed by Nobel laureate William F. Sharpe in 1966, measures the excess return a portfolio produces per unit of risk. It answers a simple question: How much return am I getting for the volatility I’m stomaching? A Sharpe ratio above 1.0 is generally considered acceptable, above 2.0 is very good, and above 3.0 is exceptional. Below 1.0 means you may be taking on more risk than your returns justify.
How the Sharpe ratio is calculated
The formula is: (Mean Portfolio Return − Risk-Free Rate) ÷ Standard Deviation of Returns. The risk-free rate is typically the yield on short-term Treasury bills — we default to 4.3% since that reflects current 3-month T-bill yields, but you can change it. To annualize a Sharpe ratio calculated from shorter-period returns, multiply by the square root of the number of periods per year (√252 for daily, √12 for monthly). This calculator handles both the period and annualized figures automatically.
Limitations of the Sharpe ratio
Sharpe treats upside and downside volatility equally, which penalizes strategies that have big winning months. The Sortino ratio fixes this by only penalizing downside deviation. Sharpe also assumes returns are normally distributed, which real trading returns rarely are — they’re often skewed with fat tails. The Probabilistic Sharpe Ratio (PSR), developed by Bailey & López de Prado (2012), adjusts for skewness, kurtosis, and sample size, giving you the probability that your true Sharpe is greater than zero. PSR is shown alongside the raw Sharpe above. Finally, Sharpe is a single number over a single window — a rolling Sharpe often tells a more honest story about consistency.
Frequently asked questions
- What counts as a “good” Sharpe ratio?
- For individual traders, above 1.0 over a multi-year window is solid. Institutional funds typically target 1.5–2.0. Anything above 3.0 over a long horizon is exceptional and often signals either a real edge or data-mining bias.
- Should I use daily or monthly returns?
- Daily returns give a more precise estimate if you have enough history (say 1+ year). Monthly returns reduce noise and are standard for fund reporting. Both are valid — the annualized Sharpe should be in the same ballpark either way.
- Is this calculator accurate?
- It uses the same formulas and risk-metric library we run on the AlphaLens dashboard for connected brokerage accounts. The underlying math is open-source in our repo.
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