Sharpe Ratio
Definition
The Sharpe ratio measures risk-adjusted return by dividing the average excess return by the standard deviation of returns. A higher Sharpe ratio indicates better return per unit of risk taken.
The Sharpe ratio is calculated as: (Average Return - Risk-Free Rate) / Standard Deviation of Returns. For traders, a Sharpe ratio above 1.0 is considered acceptable, above 2.0 is very good, and above 3.0 is excellent. The ratio tells you whether your returns are coming from skill or from taking excessive risk.
For prop traders, the Sharpe ratio is particularly relevant because it indicates how likely you are to experience large drawdowns. A strategy with a high Sharpe ratio has more consistent returns, meaning smaller drawdowns relative to profits — exactly what you need for prop firm compliance.
A low Sharpe ratio with high overall returns suggests your strategy has large swings, increasing the probability of hitting drawdown limits even if it's profitable long-term. PropJournal calculates your Sharpe ratio and other risk metrics automatically, helping you evaluate whether your approach is suitable for the specific prop firm you're trading with.
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