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Investors need indicators that can help estimate the potential profit of the above investments. (The difference between risk and reward over time). One indicator that can be used is the contrast ratio.
Definition of Contrast Ratio
The Sharpe Ratio is a ratio that compares the rate of return of an investment tool to its level of risk. It was so named because this indicator was developed by William F. Sharpe in 1966.
The Sharpe Ratio is used to help estimate past and future investment returns. The higher the value of this indicator is. The better the potential of the investment tool, the better.
William F. Sharp was an economist from the United States. developer of the theory Capital Asset Pricing Model (CAPM) and received the Nobel Prize in Economics for his work. In addition to contrast ratios and CAPM, this Stanford graduate professor developed other investment theories, such as the binomial method and how to optimize assets for a given return.
Sharpe Ratio Formula
The sharp ratio formula is Sa = (Rp – Rf ) / p.
information:
Rp : the rate of return of the instrument to be invested
Rf : The rate of return on investment is no risk.
P : Standard deviation.
The risk-free rate of return is the rate of return on other investment instruments that is considered low-risk and can be used as a benchmark. Usually what is used to fill this variable is the interest rate. government bonds and the benchmark interest rate (BI7DRR). The author therefore recommends using BI7DRR.
Standard deviation or standard deviation is a statistical distribution variable used to calculate the mean deviation of each data with the overall mean of the data. In statistics, the standard deviation can be found by raising the total variance power.
These statistical variables are required in sharp ratio to value the difference between reward and risk This is because the returns and risks of investment instruments fluctuate all the time.
How to Calculate the Sharpe Ratio and Examples
Calculation method
Contrast ratios can be calculated manually or using a spreadsheet application such as Microsoft Excel. Here are some steps you should take to calculate this tool:
- Prepare the necessary tables
- Gather information on the monthly average price of the investment tools you need.
- Calculate monthly rate of return
- Calculate the standard deviation level.
- collect information BI7DRR.
- Calculate the annual BI7DRR average as the benchmark interest rate is published monthly.
- Divide the average BI7DRR by 12 to get the same monthly risk-free rate.
- Plug the data into the equation.
Calculation example
| column number | date | BI-7Day-RR (a) | Mutual Fund A (B) | Mutual Fund B (C) | Monthly Return Fund A (d) d=b2/b1-1 | Monthly Return Mutual Fund b (e) e=c2/c1-1 |
| 1 | 23-Aug 2022 | 3.75% | 1,500 | 1,220 | ||
| 2 | 21 Jul 2022 | 3.50% | 1,250 | 1,230 | -16.67% | 0.82% |
| 3 | 23 Jun 2022 | 3.50% | 1,650 | 1,320 | 32.00% | 7.32% |
| 4 | 24-May-2022 | 3.50% | 1.325 | 1,200 | -19.70% | -9.09% |
| 5 | 19 April 2022 | 3.50% | 1,720 | 1.180 | 29.81% | -1.67% |
| 6 | March 17, 2022 | 3.50% | 1,665 | 1,110 | -3.20% | -5.93% |
| 7 | 10 Feb 2022 | 3.50% | 1,119 | 1,300 | -32.79% | 17.12% |
| 8 | 20 Jan 2022 | 3.50% | 1,800 | 1.350 | 60.86% | 3.85% |
| 9 | Average return per month (using the average function) | 7.19% | 1.77% | |||
| 10 | Standard Deviation (using STDEV function) | 34.17% | 8.76% |
| BI7DRR Average Annual (f) F= Column A Average | 3.53% |
| BI7DRR Monthly Mean (g) g= f/12 | 0.29% |
| Mutual Fund Contrast Ratio A(h)h= (d9-g)/d10 | 0.12017 |
| Sharpe Ratio B Fund (i) i=(e9-g)/e10 | 0.1688 |
From the above example In a nutshell, investing in mutual fund A is more profitable than investing in mutual fund B because A’s Sharpe Ratio is 0.117 and B is only 0.1688. Investing in Mutual Fund A will pay back 20% of the investment while investing in Mutual Fund B will pay back only 17%.
Using Sharpe Ratio in Trading and Investing
The Sharpe Ratio can be used to compare the performance of investment tools based on the funds received. This can be very useful especially for investing in mutual funds and Forex.
This is considering that both financial instruments are quite difficult to analyze based on fundamentals. Mutual funds are because they are one of the investment units for many issuers while forex because they are based on economic sentiment.
You can compare the contrast ratios of two different instruments in the same year as in the example above. or compare the contrast ratio of the same instrument in different years.
This indicator can be used to compare the results of the same instrument in different years (present and 1 year in the future) if you can predict the future movement of the underlying interest rate and expected return on investment. Answer to the question “Is investing in Instrument A still profitable in the future?”
What is a good Sharpe ratio?
There is no specific benchmark for a good contrast ratio. This is because this indicator requires a benchmark (benchmark) and cannot stand alone.
So, to find out what a good Sharpe Ratio is, you need to compare the values of this indicator from two or more different instruments in the same year or compare. sharp ratio The same instrument, but in recent years
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