What is Sharpe ratio?
The Sharpe ratio indicates how well an investment performs in comparison to the rate of return on a risk-free investment, such as US treasury bonds. It is a method developed the economist William Sharpe. It can be calculated by this formula:
is the expected return on the asset or portfolio;
is the risk-free rate of return;
is the standard deviation of returns (the risk) of the asset or portfolio
How to interpret a Sharpe ratio?
SOURCE: WOOBULL CHARTS
Aleh Tsyvinski, an economist and currently the Arthur M. Okun Professor of Economics at Yale University, published a research piece about risks and returns of cryptocurrency. Tsyvinski noticed that cryptocurrencies usually have a higher Sharpe ratio when compared to traditional bonds and stocks, it indicates that cryptocurrencies did not just have greater volatility, but the investment is worth it because it can generate higher returns.
The Sharpe ratio helps traders and investors to determine which investment has the highest returns while considering risk. However, it doesn’t provide much information in terms of price movement and prediction, rather, it’s a supporting tool to evaluate the risk/return in a portfolio, this is especially important for participants in cryptocurrency markets, which investors often face unpredictable volatility.
This post also appeared on Medium. Read more.