What is Sharpe ratio?
It's a technique to gauge the return on an investment by adjusting for risk. Nobel laureate William F. Sharpe developed the ratio in 1966 and revised it in 1994. It was originally called the reward-to-variability ratio.
Where have you heard about Sharpe ratio?
If you are an investor you find this common ratio useful to work out how you will be compensated differently for distinct levels of risk. The higher the ratio, the more attractive the risk adjusted return should be.
What you need to know about Sharpe ratio.
This ratio is an industry standard but its accuracy depends on the expected returns forming a normal distribution curve . If it doesn't, the Sortino ratio could be used. The Sharpe ratio can be tinkered with by investment managers who wish to make their history of investment choices seem better.
Sharpe ratio = (mean return − risk-free rate)/standard deviation of return
It's also known as the Sharpe index and the Sharpe measure. As with all tools in risk management there is a risk of a loss as well as a profit.
Find out more about Sharpe ratio.
To find out more, see our definitions of risk management, Roy's safety-first criterion and Sortino ratio .