Hands-On Machine Learning for Algorithmic Trading

The Sharpe ratio

The ex-ante Sharpe ratio (SR) compares the portfolio's expected excess portfolio to the volatility of this excess return, measured by its standard deviation. It measures the compensation as the average excess return per unit of risk taken:

Expected returns and volatilities are not observable, but can be estimated as follows using historical data:

Unless the risk-free rate is volatile (as in emerging markets), the standard deviation of excess and raw returns will be similar. When the SR is used with a benchmark other than the ...