What Is a Good Sharpe Ratio?

What it measures

The Sharpe ratio is the average return you earn above the risk-free rate, divided by the volatility (standard deviation) of those returns. It answers a single question: how much extra reward did you get for each unit of risk you took? A higher number means more return per unit of risk, which is what every investor actually wants.

Sharpe = (return - risk-free rate) / standard deviation of returns

Because volatility scales with the square root of time, a Sharpe ratio is almost always quoted annualized so figures are comparable. Compute it from your own return series with the Sharpe ratio calculator, which also reports maximum drawdown.

Rough benchmarks

• Below 1: sub-par, the risk isn't being well rewarded.
• 1 to 2: good, a solid risk-adjusted result.
• 2 to 3: very good, characteristic of strong strategies.
• Above 3: excellent, and rare over long periods; be skeptical of back-tests that show it.

For reference, the broad US stock market has historically delivered a long-run Sharpe ratio of roughly 0.4 to 0.5. A number far above that, sustained over years, is genuinely hard to achieve.

Why context matters

The same Sharpe ratio can flatter or mislead depending on how it was produced:

• Measurement period. A high Sharpe over six cherry-picked months says little. Sharpe ratios are most meaningful over multiple years that include a downturn.
• Return distribution. Sharpe assumes roughly symmetric returns. Strategies that sell options or take on tail risk can show a lovely Sharpe right up until a crash, because standard deviation understates rare, large losses.
• Frequency. Annualizing a daily Sharpe assumes returns are independent; if they trend or mean-revert, the annualized figure can be overstated.

Use it alongside drawdown

Sharpe penalizes all volatility, including upside. That's why it's worth pairing with maximum drawdown, the worst peak-to-trough fall, which captures the loss that actually tests an investor's nerve. A strategy with a great Sharpe but a brutal drawdown may be unholdable in practice, and recovering from a deep drawdown is mathematically punishing (a 50% fall needs a 100% gain, see recovering from a stock loss).

FAQ

What is a good Sharpe ratio?

As a rough guide, a Sharpe ratio above 1 is good, above 2 is very good, and above 3 is excellent. The broad stock market has historically run around 0.4 to 0.5 over the long term.

Is a higher Sharpe ratio always better?

Generally yes, more return per unit of risk is better, but the number must be earned over a long enough period and on a return distribution that isn't hiding tail risk. A high Sharpe over a short window or from an options-selling strategy can be misleading.

What is the Sharpe ratio formula?

Sharpe ratio equals the average return minus the risk-free rate, divided by the standard deviation of returns. It is usually annualized so figures over different periods are comparable.