The Sharpe ratio takes the mean of periodic returns (daily, weekly or monthly), subtracts a risk-free rate and divides by the standard deviation of those returns. It is usually annualised. A higher Sharpe means a smoother path for the same return. Because it treats upside and downside volatility the same way, some traders prefer the Sortino ratio, which only penalises the downside.
Example
A strategy earns an average of 0.1% a day with a daily standard deviation of 1.5%. Ignoring the risk-free rate, the daily Sharpe is 0.1 ÷ 1.5 ≈ 0.067. Annualised over 365 days, since crypto trades every day, it is 0.067 × √365 ≈ 1.27.
Why it matters
Sharpe puts strategies with different returns and volatility on one scale. A strategy with lower returns but a much higher Sharpe can often be sized up to beat a more volatile one at the same level of risk.
Common mistake
Trusting a high Sharpe from a short period or from a strategy with rare, large losses. Selling options or martingale-style sizing can show a smooth curve and a high Sharpe until a single event wipes out months of gains.
Put it into practice
FAQ
- What is a good Sharpe ratio?
- Above 1 annualised is generally considered good and above 2 very good. Live results usually come in lower than backtests.
- Should crypto use 252 or 365 days to annualise?
- Crypto trades every day, so 365 is common. What matters most is using the same convention when you compare strategies.
- What is the Sortino ratio?
- A variant of Sharpe that divides by downside deviation only, so strong up days do not count against the strategy.