What is the Sharpe Ratio?

The Sharpe Ratio is an institutional financial metric that evaluates risk-adjusted return. Developed by Nobel laureate William F. Sharpe, it measures excess return generated per unit of total risk (volatility). Rather than looking solely at gross percentage gains, the Sharpe Ratio reveals whether profits were achieved through genuine market edge or through unsustainable risk-taking.

How to interpret Sharpe Ratio values

• Sharpe Ratio > 1.0: Good risk-adjusted performance; returns adequately compensate for volatility.
• Sharpe Ratio > 2.0: Excellent performance; returns are consistently stable with well-contained drawdowns.
• Sharpe Ratio > 3.0: Exceptional institutional-grade performance.
• Sharpe Ratio < 1.0 (or negative): The strategy incurs excessive volatility relative to its yield, or the account is trading at an overall net loss.

Step-by-step mathematical calculation

WebTrade calculates the Sharpe Ratio across your historical trading days:

Step 1: Calculate average daily return

Sum the percentage returns across all trading days and divide by the total number of active days ($n$):

Step 2: Calculate return variance (Sum of Squares)

Measure how much each daily return deviates from the mean return:

Step 3: Calculate sample standard deviation (Risk)

Divide the Sum of Squares by degrees of freedom ($n - 1$) and take the square root:

Step 4: Calculate daily Sharpe Ratio

Divide the average daily return by the daily standard deviation (assuming a standard risk-free rate of 0 for retail margin trading):

Step 5: Annualize the Sharpe Ratio

To scale the daily metric to an annual comparison, multiply by the square root of 252 (the standard number of annual market trading sessions):

Annualized Sharpe Ratio = Daily Sharpe Ratio × √252

Practical example

Assume a trader logs 5 consecutive daily returns: +1.0%, +2.0%, -1.0%, +0.5%, +1.5%.

1. Mean return: (0.01 + 0.02 - 0.01 + 0.005 + 0.015) / 5 = 0.008 (0.8%)

2. Sum of squares: (0.01 - 0.008)² + (0.02 - 0.008)² + (-0.01 - 0.008)² + (0.005 - 0.008)² + (0.015 - 0.008)² = 0.00053

3. Standard deviation: √(0.00053 / 4) ≈ 0.01151 (1.151%)

4. Daily Sharpe Ratio: 0.008 / 0.01151 ≈ 0.695

5. Annualized Sharpe Ratio: 0.695 × √252 ≈ 0.695 × 15.874 ≈ 11.03

A high Sharpe Ratio confirms steady, predictable equity progression with low drawdown fluctuations.