Cryptocurrency derivatives trading is still a relatively new form of trading, but it’s growing in popularity at an exponential rate. As it becomes more popular, naturally it attracts more traders to dip their toes in their water and try it out, from experts to casuals. Inevitably, therefore, there is going to be a lot of questions on your mind if you yourself are a trader trying it out for the first time. But don’t worry, Bybit is here to guide you every step of the way. In this article, we will give you a basic introduction of how to compare risk-adjusted return performance measures by looking at two of the most widely-used: Sharpe Ratio and Sortino Ratio.
What Does Risk-Adjusted Return Performance Mean?
Risk-adjusted return means how much the return on investment has been in relation to the risk of the investment over a defined period of time. A risk-adjusted return performance measure is, therefore, a way of calculating this. There are several you can use, and two of the most widely used, the Sharpe Ratio, and Sortino Ratio, we will look at in this article.
This ratio is the most widely used by investors to calculate their risk-returns. It measures the performance of an equity investment in relation to a risk-free investment. It also considers the risk involved in holding the risk-free investment. It takes into account the volatility, or total risk, of the investment. The higher the ratio, the better, and above 3.0 is considered excellent. On the other hand, a ratio below 1.0 is not considered favorable.
The Sortino Ratio has similarities to the Sharpe Ratio in that also calculates the standard deviation of the returns of an investment, but it only takes into account the negative volatility. In addition, the Sortino ratio uses a compounded return, which matches actual return over the entire period, whereas the Sharpe ratio uses an arithmetic average return.
Which Risk-Adjusted Performance Measure is Best?
In actuality, the ratios can both be good performance measures to use but in different situations. The reasoning behind the Sortino Ratio is that positive volatility, where essentially an investment is making money, is an advantage, and therefore should not be taken into account in any risk assessment. Indeed, many investors will probably tell you that is only really concerned about the impact of negative volatility, and so will prefer to use this ratio.
Of course, that doesn’t necessarily mean it’s best for everyone. Because positive returns are penalized the same as negative returns, the Sharpe Ratio is perhaps better if you’re looking for consistent returns in a low volatility market. However, if you’re looking for quick returns on your investment in a high volatility market, then perhaps the Sortino Ratio is the better risk-adjusted return performance measure for you. In terms of cryptocurrency trading, the same logic can be applied. Some traders trade in cryptocurrencies in order to try and make some quick profit, in which case the Sortino Ratio is more applicable. For those trading as a long-term investment, then the Sharpe Ratio is more applicable.
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