Who this is for — Anyone who wants to compare different strategies accounting not only for how much they return, but also how much they oscillate.
The Sharpe ratio relates average return to return variability. It helps you see how much performance you obtain per unit of risk taken.
In plain terms — Earning is not enough: how bumpy the path matters. A high Sharpe means a more efficient path.
Bronze prerequisite — Before this lesson: drawdown, risk-per-trade, risk-reward-ratio, r-multiple. See bronze-path.
Limits and correct interpretation
The Sharpe ratio is useful, but read it with caution:
- Works better on large samples (sample-size).
- Assumes regular distributions that real markets often lack.
- Can improve artificially with result smoothing.
Use it to compare similar methods, not as absolute truth about the strategy.
Example — Strategy A returns 18% annually with strong swings, Sharpe 0.8. Strategy B returns 14% with more contained fluctuations, Sharpe 1.3. In many contexts B is more sustainable, especially with external capital.
Common mistakes
- Comparing Sharpe across different time periods without normalisation.
- Ignoring deep drawdowns.
- Using it on series that are too short.
- Evaluating single trades with a metric designed for return series.
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- What it is: ratio of average return to return volatility.
- Why it matters: compares efficiency of strategies with different risk.
- Caution: does not replace drawdown and robustness metrics.
Silver path — Module: Operational metrics. Part of silver-path.