This old man is 1990 Nobel laureate William F. Sharpe. He might look boring to you, but his sharp investment models will help you make some money. He is best known from immodestly named Sharpe Ratio that calculates risk to return. Read on to see the formula and figure out Sharpe ratio on your investments too.
The formula
Where:
Rp: Portfolio return: Your total gains.
Rf: Risk-free rate: This is the theoretical rate of return of an investment with zero risk. It’s a constant that you should assume over a specified amount of time, like 3% per year that you should get from bank deposit interest or 1-yr bonds available to you.
σp: Standard deviation of portfolio’s excess return: Ah, the favorite tool of every statistician. Just push that excess return into Excel for every asset traded and use STDEV function to get it right.
As you can see, it’s not hard at all, although the main limitation is that actual ratio can be calculated ex-post that is when the gains or losses are incurred. If your results are above 0.5 – congratulations, your investment is really safe! ETFs traded on NYSE get it around 0.3-0.5.
You can find Sharpe ratio for ETFs on their websites like in HMMJ. Weed stocks aren’t reliable source of income as you can see!
How to apply Sharpe ratio in your trading?
Etoro’s @SharpTraders portfolio collects 20 best eToro traders by Sharpe ratio, managed by eToro’s committee. I just got into this fund as one of the 20 best investors you can find there! You can simply copy my trades using eToro’s Social Trading system to invest safely and with consideration for proper, low risk trading.
Part of Etoro’s @SharpTraders list for July. Each selected investor is responsible for 5% of total fund volume, and its composition is adjusted each month.
And if you’re using other broker, consider following steps to increase Sharpe Ratio:
- Go as low as you can with leverage if any,
- Pick low volatility instruments (ie. unleveraged blue chip stocks, bonds) and make them major part of your portfolio,
- Limit yourself to number of trades daily to avoid whipsawing
- Don’t daytrade
- Diversify your assets
- Stop trading oil 🙂
