To improve Sharpe Ratio you'll need to first increase your depth in understanding it. Sharpe ratio is comprised of two main components:

(1) **Volatility:** Sharpe Ratio tries to even out the fact that if you’re taking a lot of risk in your portfolio, you would have to a large enough return to justify that risk.

(2) **Average Return:** On EquitySim we take the daily change between each day, and take the average of those returns.

## Volatility

**Volatility** is a measure in finance to quantify the "ups and downs" in the price over a period.

With a volatile security, the fluctuations of your potential profits and losses are larger. There is more of a "luck" factor with these investments as you may have a great total return today, but if it is a volatile investment these returns could be gone in a matter of a few days.

Volatility is the** Standard Deviation **of your daily returns.

## Standard Deviation

Standard deviation measures the amount of variation in a set of values. With regards to volatility, standard deviation is used to calculate how much daily returns fluctuate.

Standard Deviation will take all of your daily return rates as inputs, and start by calculating the average (known as the mean). From this starting point, it will determine 3 buckets of variation. Each variation bucket is known as a standard deviation. Standard Deviation is notated with the symbol "sigma" : **σ. **

Each bucket is named 1**σ, 2σ, 3σ. **On the spectrum, the middle is your mean (average), and each bucket goes above and below this middle. ** **

The curve fits all your data points under it, and uses **σ **to notate its abnormality.** **+/- 1σ encompass 68.2% of the data points, +/-2σ covers 27.2% data points, +/- 3σ cover 4.1% of the data points, and anything greater than 3σ is 0.2% of data points. ** **

**σ is one number,** the larger the number the more variability in your returns. Sharpe Ratio says: if you have large variability, then you need large returns to compensate.

Example: If σ = 1.5% , and the mean (average) is = 0.5% ;

+1σ = 2% and -1σ = -1%. This means approximately 68.2% of the time your daily returns are between -1% and +2%**. **

In this case your Sharpe Ratio would be 0.3.

0.5% (Average Return) / 1.5% (Standard Deviation)

Historical performance is often a good indicator of the Volatility of a company.

## Average Returns

On EquitySim, volatility considers a security's daily return for the last 90 trading days. The average return is the average of those inputs.

Unlike Volatility, historical returns are NOT a good indicator of the future returns of a company. This is where your skill comes into play, there is yet a "crystal ball" that can predict future prices, but it is the job of an active manager to choose which companies will outperform.

## Conclusion:

Use historic performance to predict the volatility of an investment, and develop your own formula to determining the expected returns of the investment. Your ability to find the investments with good volatility - expected return tradeoffs will be how you beat the Sharpe Ratio challenge.