Sign In   Register

ADVERTISEMENT



What is Sharpe ratio in forex?

Continuing in our series of article about how to understand the trading signal statistics, we start off with the Sharpe ratio. As with any ratios, on their own, the values are meaningless. But they bring out new information if you are comparing different funds or signal providers.

Readers should bear in mind that the first statistical measure outlined in this article is just one of the many. Therefore, do not base your judgements merely on just one measure. In fact, there is a lot more science than just analyzing or comparing the ratios.

So, let’s get started with the Sharpe ratio. This is one of the most common metrics that you will find. Whether you are looking to invest in an equity fund, a forex managed account, or even a trading signal provider, Sharpe ratio is common to all.

It is a ratio, at the very basic and the Sharpe ratio is used to measure how well you are compensated for the risk that you take.

Understanding the Sharpe ratio when choosing a forex signals provider

We will start off with one of the first metrics that you can commonly see across a trading signal provider’s statistics data which is called the Sharpe Ratio. The Sharpe ratio is a number (often in decimals).

Note that Sharpe ratio is applicable in just about every other market, including funds. The picture below shows where you can find the Sharpe ratio from a trading signal provider’s statistics page.

01 Sharpe Ratio

Example of Sharpe Ratio in MQL5 Trading Signals Provider

Sharpe ratio measures the returns of a portfolio, based on a risk-adjusted basis. It is a ratio that compares profitability to the risk it takes.

Sharpe ratio helps one to understand the return on their investment, comparing it to its risk. The usual philosophy is that when the risk is greater, the returns should compensate for taking this additional risk.

Thus, the Sharpe ratio tells you the returns earned, in excess of the risk-free rate, per unit of volatility. Sharpe ratio is calculated by subtracting the risk-free rate from the mean returns of a portfolio. This helps investors to isolate the profits that come because of taking on more risk.

As a thumb rule, a higher Sharpe ratio is preferred. But it is important to note that a Sharpe ratio on its own is useless. A low Sharpe ratio means that you are getting poor returns.

The Sharpe ratio brings meaning, when you compare the value to another trading signal provider.

A Sharpe ratio of 0.5 means that you will earn $5 if you take on the risk of losing $10. In the above example, you see a Sharpe ratio of 0.18. This means that for a risk of $10, you can expect a gain of $1.80.

Where to use the Sharpe ratio?

As mentioned earlier, Sharpe ratio on its own does give much meaning. But it can help you when you are comparing two similar signal providers. For example, if there are two signal services you are interested in, and both give more or less the same amount of returns of growth, the Sharpe ratio can help break the tie.

Sharpe ratio can also help you to understand whether you are paying a premium or fair value when subscribing to the signal provider.

Here’s a quick table to help you understand the Sharpe ratios better. Note that the ratios can change depending on the type of market. For example Sharpe ratios for equity funds start around 1.00, whereas in the forex markets, it is different.

Sharpe Ratio

Risk Rate

Verdict

< 0.50

Take on very little risk

Not a good strategy to invest in

0.50 – 1.00

High Risk

Well compensated for risk taken

> 1.00

Very High Risk

Returns are compensated very well for the risk taken

Bear in mind that you will see higher Sharpe ratios for trading signals when they are new or haven’t taken any big loss.

In conclusion, the Sharpe ratio is a metric that one should use when they have already identified a couple of signal providers. This ratio will help you to then weed out the low risk taking ones against the other.

Note that there is nothing wrong is investing in a low risk taking fund or a copy signal provider. At the end, it is up to every individual trader. Also note that there is no perfect Sharpe ratio. Each trader’s investment profile is different.

Therefore, you should look at approaching the trading signal provider’s evaluation on an individual basis and not use a general benchmark.

Read 644 times

ADVERTISEMENT

ADVERTISEMENT

ADVERTISEMENT

ADVERTISEMENT

ADVERTISEMENT