Sharpe Ratio Calculator

The Sharpe Ratio is calculated by subtracting the risk-free rate from the portfolio's mean return to obtain the excess return, then dividing by the standard deviation of those excess returns. The risk-free rate is typically represented by short-duration government securities — such as the 3-month U.S. Treasury bill — and serves as a baseline for what an investor could earn without accepting any meaningful risk. By netting this baseline out of portfolio performance, the Sharpe Ratio isolates the compensation earned purely for bearing market risk.

The denominator, standard deviation, captures total volatility — both upside and downside price swings. This is an important distinction from metrics like the Sortino Ratio, which penalises only downside volatility. Because the Sharpe Ratio uses total standard deviation, a strategy that generates unusually high positive returns will appear slightly penalised relative to a smoother strategy with identical average returns, since the large positive deviations increase σ. For normally distributed returns, however, this effect is symmetric and the ratio remains a robust summary statistic.

When working with daily or monthly return series, practitioners often annualise the Sharpe Ratio by multiplying by the square root of the number of periods in a year: √252 for daily trading returns, √52 for weekly, or √12 for monthly. This scaling is derived from the assumption that returns are independent and identically distributed (i.i.d.), which allows variance to scale linearly with time. A daily Sharpe of 0.10 therefore corresponds to an annualised Sharpe of approximately 1.59, a figure considered strong for a diversified long-only strategy.

The Sharpe Ratio assumes that returns are approximately normally distributed, making it less reliable for strategies with significant skewness or excess kurtosis — such as options-selling, event-driven, or momentum strategies that exhibit fat tails and occasional large drawdowns. A strategy that earns steady small gains but suffers rare catastrophic losses can display an artificially high Sharpe Ratio over short sample periods. Additionally, the choice of risk-free rate and the annualisation period materially affects the output, so comparisons are only valid when these inputs are consistent. For strategies with non-normal return profiles, the Sortino Ratio, Calmar Ratio, or Omega Ratio may provide complementary and more appropriate measures of performance.