Sharpe = (average return − risk-free rate) ÷ standard deviation of returns
Take the strategy’s periodic returns, subtract the risk-free rate for the same period, divide the average by the standard deviation.
A worked example
A strategy has daily returns averaging 0.15% with a standard deviation of 1.2%. Assume a risk-free rate near zero.
Daily Sharpe = 0.15 ÷ 1.2 = 0.125
To annualise, multiply by the square root of the number of trading periods per year. Equities use √252. Crypto trades every day, so use √365 ≈ 19.1.
Annualised Sharpe = 0.125 × 19.1 ≈ 2.4
The mistakes that inflate it
Using √252 for a crypto strategy understates the periods and overstates the ratio. Using a short window — a few good weeks — produces a figure that has no relationship to what the strategy does over a year.
Backtested Sharpe ratios are almost always higher than live ones, because backtests don’t pay real slippage and don’t include the losing regime that hadn’t happened yet.
What the number can’t tell you
Sharpe treats a 5% up day and a 5% down day as equally risky. It says nothing about how deep the worst drawdown was or how long recovery took. For that, read Sortino and Calmar alongside it.