Risk-adjusted return
What is the Sharpe Ratio? A Trader's Guide
The Sharpe ratio answers a simple question: how much return are you earning per unit of risk taken? It's the single most important number on a backtest report.
The formula
Sharpe = (mean return − risk-free rate) ÷ standard deviation of returns. Annualize by multiplying by √252 for daily returns, √12 for monthly. The risk-free rate is usually a short-term Treasury yield; for crypto strategies many traders just use 0.
What is a 'good' Sharpe?
Below 1.0: the strategy is taking on too much volatility for the return it produces. 1.0–2.0: tradable, the territory most retail strategies live in. Above 2.0: excellent, but be skeptical of overfitting if you see this on a single in-sample backtest.
Common pitfalls
Sharpe assumes returns are normally distributed — they aren't. A strategy that sells crash insurance can show a beautiful Sharpe right up until it blows up. Always pair Sharpe with max drawdown and look at the full equity curve.
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