Definition
The Sharpe ratio is a quantitative measure used to evaluate how much excess return an investment generates for each unit of risk taken. It is calculated by subtracting the risk-free rate from an asset or portfolio’s return and dividing the result by the standard deviation of returns, which serves as a proxy for volatility. A higher Sharpe ratio indicates that, historically, the investment has delivered more return per unit of risk compared with alternatives using the same benchmark. In crypto and other high-risk markets, it is often used to compare strategies or portfolios with different risk characteristics on a normalized basis.
Context and Usage
As a risk-adjusted performance concept, the Sharpe ratio links raw returns to the underlying volatility of those returns, making it sensitive to an asset’s risk profile. It assumes that volatility, measured through standard deviation, is an appropriate representation of risk and treats upside and downside deviations symmetrically. In practice, the ratio is applied across time series of returns, such as daily or monthly performance, and then annualized for comparability. Within crypto trading, it is commonly referenced when assessing whether higher returns are simply a function of extreme volatility or reflect more efficient risk-taking.