Sharpe Ratio assess the risk of an investment or trading strategy compared to its past or expected returns.
This ratio is calculated by subtracting the risk-free rates from the expected returns and dividing the result by the volatility/standard deviation of the former.
Sharpe Ratio aims to measure the consistency of returns and due to this emphasis, is heavily influenced by the standard deviation of monthly returns.
A higher Sharpe value demonstrates high consistency of returns month-over-month when compared to a lower Sharpe value strategy.
It's important to note that high-risk or volatile investments generally display a poor performance on this metric independently of their returns, as such, two strategies cannot be compared solely based on this ratio. It's rather a metric to help make an informed decision between 2 or more investments with similar returns.
Here's how we calculate Sharpe Ratio:
Typically, this ratio is calculated using annual values, but this method doesn't provide reliable results in cryptocurrency investments or trading strategies due to a lack of sufficiently lengthy market data. To solve this issue, we calculate Sharpe using monthly returns for increased accuracy.
We've also assumed a risk-free rate of 8% for our calculations based on the current lowest risk investment market offerings, stable-coin staking platforms such as Nexo, BlockFi, Celsius.
(Mean Monthly % Returns - Monthly Risk-free Rate (8%/12)) / Standard Deviation of returns.
We then annualize this value by multiplying it by √12.