What is a good Sharpe ratio for a trading strategy?
A good Sharpe ratio for a trading strategy is generally above 1.0 — above 2.0 is very good and above 3.0 is excellent. Because live trading almost always underperforms a backtest (spread, slippage, latency and changing market regimes all take a bite), leave headroom: treat a high backtested Sharpe ratio with caution and expect the realised, live figure to come in lower.
| Sharpe ratio | Rating | What it means for a systematic trader |
|---|---|---|
| Below 0 | Poor | Returns trail the risk-free rate — you would do better in T-bills |
| 0 – 1.0 | Weak | Below what most quant funds would trade; often not worth it after costs |
| 1.0 – 2.0 | Good | A solid, tradeable systematic strategy after transaction costs |
| 2.0 – 3.0 | Very good | A strong risk-adjusted edge; a sensible target for retail algo traders |
| 3.0 and above | Excellent | Institutional-grade — in a backtest, double-check for overfitting |
The Sharpe Ratio is a widely used metric for evaluating investment performance and risk-adjusted return. It measures the excess return per unit of risk taken by an investment and helps investors compare different investment options. In simple terms, the Sharpe Ratio indicates whether an investment’s returns are due to smart investment decisions or a result of excessive risk-taking.
The formula for the Sharpe Ratio
(Return of the Investment – Risk-Free Rate) / Standard Deviation of Returns
The risk-free rate is typically represented by the return on a government bond and is used as a benchmark for measuring an investment’s excess return. The standard deviation of returns measures the volatility of an investment’s returns.
An investment with a higher Sharpe Ratio is considered to be more attractive than an investment with a lower Sharpe Ratio as it indicates a higher return per unit of risk taken.
Worked example
Consider two investments, Investment A and Investment B, with the following returns:
Investment A: 10% return with a standard deviation of 5%. Investment B: 12% return with a standard deviation of 8%.
Assuming a risk-free rate of 2%, we can calculate the Sharpe Ratio for each investment as follows:
Investment A: (10% – 2%) / 5% = 1.2. Investment B: (12% – 2%) / 8% = 0.7.
In this case, Investment A has a higher Sharpe Ratio of 1.2 compared to Investment B’s 0.7, indicating that Investment A provides a higher return per unit of risk taken.
Frequently asked questions
Is a Sharpe ratio above 2 good?
Yes. A Sharpe ratio above 2.0 is considered very good and signals a strong risk-adjusted return. For a systematic strategy it is a realistic target — but confirm the figure holds out-of-sample and in live trading, not only in a backtest.
What Sharpe ratio do hedge funds look for?
Most quantitative hedge funds want to see a Sharpe ratio of at least 1.5–2.0 on a strategy before allocating capital, because they need consistency rather than just high returns. Very short-term and high-frequency desks often require considerably higher.
Why is my live Sharpe ratio lower than my backtest?
Backtests underestimate real trading frictions — spread, slippage, commissions, execution latency and market regimes the sample never saw. It is normal for a live Sharpe ratio to land well below the backtested one, which is why you should build in a margin of safety.
Can a Sharpe ratio be too high?
In a backtest, yes — an unusually high Sharpe ratio (for example above 4 on a retail strategy) is often a red flag for overfitting or curve-fitting rather than a genuine edge. Always validate a very high Sharpe out-of-sample before trusting it.
What is a good Sharpe ratio for an intraday strategy?
Intraday and higher-frequency strategies typically aim for a higher Sharpe ratio than swing strategies because they take many more trades, spreading returns across more independent bets. See our guide to trading intraday strategies using market regimes.
How does the Sharpe ratio compare to other metrics?
The Sharpe ratio measures risk-adjusted return, but no single metric tells the whole story. Read it alongside R-expectancy, profit factor, Z-score and CAGR and the System Quality Number (SQN) to judge a strategy properly.
Want to see risk-adjusted performance on real money? We publish our live trading portfolio results every month.
