What is Sharpe Ratio?

Developed by Nobel Prize-winning economist William F. Sharpe, the Sharpe ratio is a metric that helps measure the performance of a portfolio compared to risk-free assets. In other words, it can be expressed as a ratio that measures the level between the return and risk of the portfolio created.

If you have questions like what is the Sharpe ratio, how to evaluate the Sharpe ratio, or how to use the Sharpe ratio in the cryptocurrency markets then you will find the answers in this article.

What is Sharpe ratio?

The Sharpe ratio, which is stated to measure the relationship between the return and risk of an investment portfolio, is also used to compare portfolios consisting of similar investment instruments. Each portfolio has its own risk level. This ratio shows how much risk is taken against return or potential return. It is stated that the Sharpe ratio aims to measure the performance of the portfolio by adjusting the return exceeding the risk-free interest rate according to its own risk.

What is the Sharpe ratio formula?

The Sharpe ratio can be found with a simple calculation. For this, three variables are needed. These are the actual or potential return (Rp) of the asset or portfolio, the risk-free rate of return (Rf) and the standard deviation (σ) representing the risk of the portfolio, respectively. The formula for the Sharpe ratio is as follows:

Sp= (Rp-Rf) / σ

How should the Sharpe ratio be evaluated?

According to experts who interpret the use of the Sharpe ratio, if an asset added to the investment portfolio increases the Sharpe ratio, its contribution to the investment basket is positive. On the other hand, in the opposite scenario, the asset increases the risk of the portfolio.

The use of Sharpe ratio in cryptocurrency markets

In cryptocurrency markets, the Sharpe ratio can also be applied on a single asset basis or in portfolio form. In this way, the performance of cryptocurrencies among themselves or with other instruments can be evaluated. However, experts are of the opinion that, due to the volatile nature of cryptocurrencies, it would not be the right approach to make an investment decision by looking at this variable alone.