Sharpe Ratio
Excess return per unit of total volatility.
What is Sharpe Ratio?
(Portfolio return minus risk-free rate) divided by standard deviation. It answers whether returns justified the ride. Comparing Sharpe ratios is more meaningful than comparing raw returns across different risk levels.
Sharpe Ratio: a worked example
12% return, 3% risk-free, 15% standard deviation gives a Sharpe of 0.60.
More terms in Risk & Return
Systematic Risk (Market Risk)
Risk affecting the whole market that diversification cannot remove.
Unsystematic Risk (Specific Risk)
Company- or industry-specific risk that diversification can eliminate.
Beta
How much a security moves relative to the overall market.
Alpha
Return above what the portfolio's risk exposure would predict.
Standard Deviation
How widely returns disperse around their average.
Correlation
How closely two assets move together, from -1 to +1.
Diversification
Spreading capital across assets so no single failure is fatal.
Maximum Drawdown
The largest peak-to-trough decline over a period.