Sharpe ratio

The Sharpe ratio quantifies the performance of an investment by adjusting its return for risk. It is calculated by subtracting the risk-free rate from the investment's return and then dividing the result by the investment's standard deviation (a measure of volatility). A higher Sharpe ratio indicates a better risk-adjusted return, meaning the investment provided more return for the amount of risk assumed.

For a retail trader, the Sharpe ratio helps evaluate the efficiency of a trading strategy. A strategy with a higher Sharpe ratio suggests it generates returns more consistently relative to its volatility, indicating better risk management. Traders can use it to compare different strategies or portfolios, aiming to select those that offer superior returns without taking on disproportionately higher levels of risk.