What is Risk-Adjusted Return?
Risk-adjusted return measures how much return an investment generates relative to the amount of risk taken, providing a more complete picture than raw returns alone.
Risk-Adjusted Return Explained
Two strategies might both return 20% annually, but if one has smooth, consistent returns while the other has wild 30% swings, the first is superior on a risk-adjusted basis. Metrics like Sharpe ratio, Sortino ratio, and Calmar ratio all measure risk-adjusted performance in slightly different ways. Smart money always evaluates risk-adjusted returns, not just absolute returns.
Real-World Example
Trader A makes 50% per year but has 40% drawdowns. Trader B makes 30% per year with only 10% drawdowns. While Trader A has higher absolute returns, Trader B has far better risk-adjusted returns and will likely survive longer in the markets.
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