Sharpe Ratio Calculation

The Sharpe Ratio is a widely used metric that calculates the excess return of an investment per unit of risk, specifically standard deviation. It is defined as the average return minus the risk-free rate, divided by the standard deviation of returns.

A higher Sharpe ratio indicates a better risk-adjusted performance, making it a favorite among institutional investors for comparing strategies. In the context of cryptocurrency, where the risk-free rate is often treated as zero or based on staking yields, the ratio helps quantify the "quality" of the returns.

However, it assumes returns are normally distributed, which is rarely the case in crypto markets that exhibit "fat tails" and extreme events. Despite this limitation, it remains a foundational tool for portfolio management and strategy evaluation.

Traders use it to determine if a strategy's performance justifies the volatility experienced. It is a critical component of any comprehensive quantitative performance report.