The Sharpe ratio is a number that tells you how much return you are getting for the risk you are taking in your investment or trading. A higher Sharpe ratio means you are earning better returns for the risk taken. You can use the Sharpe ratio to compare different stocks, mutual funds, or portfolios and pick the one with the best risk-adjusted return.

What Is Sharpe Ratio in Simple Terms?

The Sharpe ratio is a tool used to check how much extra return you are getting for the risk you are taking in an investment. It helps you understand if the return is worth the risk. A higher Sharpe ratio means better performance with less risk. If the Sharpe ratio is low, it means the risk is high compared to the return.

How Is Sharpe Ratio Calculated?

Sharpe Ratio = (Return of the Investment − Risk-Free Return) ÷ Standard Deviation of Return. The result shows how much return you are getting for every unit of risk taken. A ratio above 1 is considered good, above 2 is very good, and above 3 is excellent.

How Can You Use Sharpe Ratio in Trading?

You can use the Sharpe ratio to compare different trading strategies or assets. The one with the higher Sharpe ratio is better because it gives more return for the same or lower risk. It helps traders choose the best stocks, mutual funds, or portfolios to invest in with more confidence.

What Is a Good Sharpe Ratio?

A good Sharpe ratio is above 1. It means your investment is giving better returns than the risk you are taking. A ratio above 2 is considered very good, and above 3 is excellent. If the Sharpe ratio is below 1, it means the risk is more than the reward and you should be careful.

How Does Sharpe Ratio Help in Comparing Mutual Funds?

When comparing mutual funds, the Sharpe ratio helps you know which one is giving better returns for the risk taken. Two funds may give the same return, but the one with a higher Sharpe ratio is safer and more efficient. So always check the Sharpe ratio before investing in any mutual fund.

Can Sharpe Ratio Be Negative?

Yes, the Sharpe ratio can be negative. It happens when your investment is giving lower returns than the risk-free rate. A negative Sharpe ratio means the investment is not good and is giving poor returns for the risk. You should avoid such investments or recheck your strategy.