Forex glossary
Sharpe Ratio
The historical mean excess return divided by the standard deviation of the same excess-return series over matching periods. A changing benchmark requires period-by-period differences; a zero denominator is undefined, and the ratio does not capture every risk.
Illustrative example
How does it work in practice?
For three hypothetical monthly excess returns of 1%, 2% and 3%, mean is 2% and sample standard deviation using n − 1 is one percentage point. Sharpe equals 2 without annualization.
A case to work through
A changing benchmark
Model: monthly fund returns 4% and 1%; benchmark returns 2% and 0%.
- Excess returns are 2% and 1%, averaging 1.5%.
- Calculate the denominator from those differences rather than raw 4% and 1% returns.
What follows? Use one excess-return series in both parts of the ratio.
Example boundary: Two months are an exercise, not a reliable strategy assessment; no annualization is used.
A useful distinction
Sharpe Ratio / Sortino Ratio
Sortino uses shortfalls from a target; Sharpe uses deviation of the whole excess-return series.
Check your understanding
Construct excess returns period by period.
Show the answer and explanation
2%, 0.5%
The benchmark is subtracted in each matching period.
Net results and risk measures
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Related terms
Sources and documentation
- William F. Sharpe: The Sharpe Ratio
Period-by-period benchmark differences, matching mean/deviation series and time dependence.
Document read:
The example illustrates the mechanism. Check current account conditions and instrument specifications with the provider.