What Is the Sharpe Ratio, in Plain Words

Two roads to the same place

Two accounts make the same money over the same year. One gets there in small, even steps; the other in large swings that could as easily have gone the other way. A return cannot tell them apart, because the return is the same. The Sharpe ratio can: it is the average return divided by the wobble of the returns — the standard deviation, the typical distance of each period's return from the average. The same return with less wobble is a larger number. That is the whole idea, and the rest is the arithmetic.

The four steps

On a real list the steps are four. The ten-day list — one lot of the euro against the dollar bought at each day's open and sold at its close, 24 August to 4 September 2026 — gives ten daily returns, each day's result as a share of the balance that morning. Their average is minus 0.88 per cent. Their standard deviation, worked as in the paper on that subject, is 7.03. The average divided by the deviation is minus 0.13. The full version subtracts a risk-free rate from the average first — what the money would have earned sitting still — and over ten days that is too small to change the answer.

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