What Is The Sharpe Ratio?
The Sharpe Ratio is the portfolio risk premium divided by the portfolio risk. This ratio is used to measure the performance of an investment fund or portfolio and is calculated using the historical standard deviation of the returns. The Sharpe ratio, or reward-to-variability ratio, is the slope of the capital allocation line that illustrates the relationship between the fund’s expected returns and its associated risk. A higher Sharpe ratio indicates that the investment fund or portfolio is achieving higher returns for the same amount of risk as opposed to a fund with a lower Sharpe ratio.
What Is The Treynor Ratio?
The Treynor ratio is also a measure of a fund’s risk-adjusted return. The Treynor ratio is the ratio of the portfolio’s return in excess of the risk-free rate divided by the portfolio’s systematic risk. A higher Treynor ratio indicates more reward for the same amount of risk and is therefore considered to be a more attractive investment.
Comparing Treynor Ratio vs Sharpe Ratio in Forex Trading
When it comes to trading forex, both the Treynor and the Sharpe ratio are useful in evaluating different investment options. The Sharpe ratio is typically used to compare the risk-adjusted performance of an investment fund in relation to its return. The Treynor ratio is more useful for comparing different funds and stocks within a portfolio. This ratio examines the average return of an investment less the risk-free rate, divided by the total risk associated with the investment.
By measuring both the Treynor and the Sharpe ratios, investors can have a clearer comparison of which investments in their forex portfolio have a higher return and which investments have a lower risk-adjusted return. For investors, having an understanding of both of these ratios can help in making more informed decisions when selecting forex investments. The combination of Treynor and Sharpe ratios helps investors to evaluate and diversify their investment portfolios, thus minimizing the risk of losses and maximizing returns. and educative
Treynor Ratio vs Sharpe Ratio Review
Investing in forex or any other financial market can be a tricky experience. To make the right decisions, it is essential to understand all the tools available to measure the performance of the market. Two concepts that are incredibly helpful in this regard are the Sharpe ratio and the Treynor ratio – both of which are used to measure the performance of funds or securities portfolios. This article will take a deeper look at these two concepts, their differences and similarities and their practical applications.
What is the Sharpe Ratio?
Originally developed in 1966, the Sharpe ratio is a tool designed to measure the excess return of an asset (or portfolio) against that of a risk-free rate of return. By comparing a given asset to the risk-free rate of return, a prospective investor in the asset can accurately gauge the expected returns of the asset as well as estimates the risk associated with it. The Sharpe ratio is calculated as the average return of a portfolio divided by its standard deviation. The higher the Sharpe ratio, the higher the expected returns of the portfolio relative to its risk.
What is the Treynor Ratio?
The Treynor ratio, another measurement tool developed by Jack Treynor in 1965, is similar to the Sharpe ratio. However, the Treynor ratio takes into account the beta of the asset or portfolio, which is a measure of systematic risk. Systematic risk is the amount of risk in an asset or portfolio that is related to the entire market. By taking into account the beta, the Treynor ratio can give prospective investors a more accurate assessment of how much risk they are taking on by investing in a given asset. The Treynor ratio is calculated by subtracting the risk-free rate of return from the average return of the asset, and then dividing by the beta of the portfolio. The higher the Treynor ratio, the more reward you will experience given the level of risk you are taking on.
The Differences between The Sharpe Ratio and The Treynor Ratio
Whilst both the Sharpe ratio and the Treynor ratio are used to measure the performance of assets relative to the risk-free rate of return, they have some distinct differences. Firstly, Sharpe ratio captures the past performance of the fund, whereas Treynor ratio is more useful as an indicator of future performance. While Sharpe ratio measures total risk (as the degree of volatility in returns captures all elements of risk – systematic as well as unsystemic), the Treynor ratio gives a better measurement of market beta – the systematic risk within the portfolio. Lastly, Sharpe ratio does not take into account the qualitative nature of risk, whereas Treynor ratio does to some extent in terms of the sector-specific risk.
The Advantages and Disadvantages of the Treynor Ratio and Sharpe ratio
One of the main advantages of the Sharpe ratio is that it is easy to calculate and understand, and also provides investors with an easy to understand measure of risk relative to returns. However, some consider the Sharpe ratio to be too simplistic, as it does not capture all elements of risk, and the variation of returns over time. On the other hand, the Treynor ratio is a more sophisticated tool that is able to take into account market beta, and provide more accurate measures of risk-adjusted returns. However, it is harder to understand and calculate, and some do not believe that it accurately captures all aspects of risk.
In conclusion, both the Sharpe ratio and the Treynor ratio are important tools for assessing the performance of a portfolio, and both have advantages and disadvantages. If you are looking to assess the risk-adjusted returns of a portfolio, then understanding and using both of these tools can be incredibly helpful.