Sharpe ratio

Also seen as: Sharpe, risk-adjusted return

How is the Sharpe ratio calculated?

The Sharpe ratio subtracts the risk-free baseline from the strategy's annualized return, then divides what is left by the strategy's annualized volatility.

where: the numerator is the excess return — the part of the return earned above a near-riskless baseline — and the denominator is the strategy's annualized volatility, the standard deviation of its returns scaled to a per-year figure with the square-root-of-252 convention. Because a percentage is divided by a percentage, the result is a plain number with no unit.

Which risk-free rate does Fincanva use?

Fincanva subtracts a real market rate, not a fixed assumption: the 3-Month US Treasury Bill secondary-market rate, published by FRED as the series DTB3 (a daily series running from 1954). A short-term government bill is the standard textbook proxy for a near-riskless return, and using a live series means the baseline moves with the era your backtest covers — a strategy tested through a high-rate decade is held to a higher bar than one tested through a near-zero-rate decade.

The rate is matched to your backtest's own date window. The risk-free rate page is the canonical description of the series, including what happens when the data is unavailable for a date.

Which return feeds the Sharpe ratio, CAGR or AAGR?

The annualized-return term follows the same Reinvest profits switch as the metrics page's annualized-return row: it is the CAGR when Reinvest profits is on, and the AAGR when it is off.

This matters when comparing runs, because AAGR ignores compounding and usually reads higher than CAGR over multi-year gains. Two backtests of the same strategy that differ only in the Reinvest profits setting therefore feed different numerators into the Sharpe ratio, and their Sharpe values are not directly comparable.

Defaults in Fincanva

• The metrics table shows it in the Volatility and risk group as the row Sharpe, as a plain number; the KPI strip and the Strategy analytics table call the same figure Sharpe ratio and Sharpe respectively.
• The by-year table repeats it per calendar year, computed on that year's own return and volatility.
• The numerator uses CAGR with Reinvest profits on and AAGR with it off; the denominator is always the square-root-of-252 annualized volatility.
• The risk-free rate row on the same metrics table shows the period average of the baseline the numerator subtracts, so you can see the two inputs side by side.
• It turns negative whenever the annualized return fell below the risk-free rate over the period — the strategy earned less than a near-riskless baseline.

Worked example

A strategy returns 11% a year over its backtest while the risk-free rate averaged 3% over the same window, and its annualized volatility was 10%. The excess return is 11% − 3% = 8 percentage points, so the Sharpe ratio is 8 ÷ 10 = 0.8: the strategy earned 0.8 units of excess return for each unit of volatility.

Now take a second strategy that returned the same 11% a year with volatility of 20%. Its excess return is the same 8 points, but its Sharpe ratio is 8 ÷ 20 = 0.4 — the same reward, from twice the variability. Headline return alone would have called these two identical.

What counts as a good value?

A higher Sharpe ratio means more excess return per unit of variability, and a value of zero means the strategy merely matched the risk-free baseline. A negative value means it trailed that baseline. Since the ratio is a plain number, a difference between 0.4 and 0.8 is a doubling of return-per-unit-of-risk, not "0.4 percentage points".

The Sharpe ratio treats every swing as risk, upward ones included, so a strategy penalised by a burst of good months scores lower than the experience of holding it might suggest — the Sortino ratio is the variant that counts only downside variability. It also says nothing about the worst single fall, which is max drawdown, or about return against that fall, which is the return-to-drawdown ratio. And because both of its inputs are measured over the backtest's own window, Sharpe ratios from windows of different lengths or different rate environments are not like-for-like.

These figures describe what a strategy would have done on historical data, not what it will do, and no Sharpe ratio is a target to aim for or a promise about future risk. Fincanva provides no financial advice — see Is this financial advice?.