The Sharpe Ratio is a metric used to measure the performance of an investment portfolio or asset, introduced by William Sharpe in 1966. The Sharpe Ratio measures the average excess return of the investment's rate of return over the risk-free rate divided by the standard deviation of the excess returns.
The formula for the Sharpe Ratio is:
Sharpe Ratio = (Rp - Rf) / σp
Where Rp represents the average rate of return of the investment portfolio or asset, Rf represents the risk-free rate, and σp represents the standard deviation of the investment portfolio or asset.
A higher Sharpe Ratio indicates that more excess return is generated per unit of risk, indicating better performance of the investment portfolio or asset. Typically, a Sharpe Ratio greater than 1 is considered good performance.
Therefore, if an automated trading strategy has a Sharpe Ratio greater than 1, it means that the strategy is able to generate excess returns above the risk-free rate per unit of risk. This indicates that the strategy is performing well and generating excess returns for the risk taken.
Generally, a Sharpe Ratio greater than 1 is considered good performance for an investment portfolio or asset. In some cases, a Sharpe Ratio greater than 2 can be considered excellent performance. However, this does not mean that the Sharpe Ratio is the only evaluation criterion. Investors should consider other indicators and risk management strategies when making investment decisions.