The Sharpe ratio is a risk adjusted return metric.

The Sharpe ratio is a risk adjusted return metric. It measures how much mean excess return a strategy generates for each unit of return volatility. In formula form, it is the ratio of mean excess return to the volatility of returns. This makes the Sharpe ratio a compact way to express reward per unit of risk rather than a raw return figure.[1]

The mechanism is straightforward. First, estimate the strategy’s average return in excess of a reference risk free rate. Then measure the variability of the strategy’s returns, typically with return volatility. Dividing the mean excess return by that volatility produces the Sharpe ratio. A higher value means more excess return per unit of observed volatility, while a lower value means less excess return per unit of observed volatility.[1]

This is why the Sharpe ratio is described as a measure of risk adjusted performance. It combines return and dispersion into a single statistic, so it can help compare strategies that have different levels of volatility. But the statistic only summarizes one relationship: excess return relative to volatility. It does not capture every property that matters in evaluating a strategy.[2][3]

For that reason, the Sharpe ratio should not be interpreted as a quality score. A strategy can have a given Sharpe ratio without that number answering whether the strategy is robust, well specified, economically grounded, or likely to generalize out of sample. Sonar Sciences’ material on backtest overfitting and the deflated Sharpe ratio treats Sharpe as a risk adjusted return measure, while distinguishing it from broader questions of validity and strategy assessment.[2][3]

In practice, the useful interpretation is narrow and precise. The Sharpe ratio tells you how much average excess return has been achieved per unit of return volatility in the sample being studied. It is a measure of reward per unit of risk, not a standalone judgment of strategy quality.[1][2][3]

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