Algorithmic Trading
Algorithmic & Financial Definition
Sharpe Ratio
Quick Definition
A statistical metric that measures the risk-adjusted return of an investment portfolio or EA relative to its volatility.
Detailed Explanation
The Sharpe Ratio calculates how much excess return a trading algorithm generates for each unit of risk taken. A Sharpe Ratio greater than 1.0 is considered good, while values above 2.0 represent exceptional consistency.
Key Trading Rules & Takeaways
- Formula: (Portfolio Return - Risk-Free Rate) / Portfolio Standard Deviation.
- Used by hedge funds and prop firms to evaluate trader risk stability.
- Higher Sharpe Ratios reflect smooth, consistent equity growth curves.
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Frequently Asked Questions
Why is Sharpe Ratio better than raw profit percentage?
Because a 50% return achieved with smooth 5% drawdown is far superior to a 60% return achieved with violent 40% drawdowns.