Sharpe Ratio & Max Drawdown: The Two Metrics That Actually Matter

New traders look at total return. Experienced traders look at risk-adjusted return. There's a reason hedge funds and prop firms obsess over two numbers above all others: Sharpe ratio and maximum drawdown. Here's why.

Sharpe Ratio: Return Per Unit of Risk

The Sharpe ratio = (Strategy Return − Risk-Free Rate) ÷ Standard Deviation of Returns. In India, use the 91-day T-bill rate (~6.5% annualised) as your risk-free rate. A Sharpe ratio above 1.0 is acceptable; above 2.0 is excellent; above 3.0 is suspicious.

Why Two Strategies with Equal Returns Are Not Equal

Imagine Strategy A returns 40% annually but loses 8% in some months and gains 12% in others. Strategy B returns 40% but has a maximum monthly loss of 1% and gains of 4%. Strategy B is dramatically superior for live trading — you can actually hold it through bad months without panic-exiting.

Maximum Drawdown: The Gut-Check Number

Maximum drawdown is the largest peak-to-trough loss in your equity curve, measured from the highest point before a decline to the lowest point before recovery. If your strategy had ₹10 lakh at peak and fell to ₹7 lakh before recovering, your max drawdown is 30%.

Ask yourself: Can I emotionally and financially survive this drawdown happening early? If your answer is no, the strategy isn't right for you regardless of its long-term return.

Calmar Ratio: Combining Both

Calmar Ratio = Annual Return ÷ Max Drawdown. A strategy returning 30% with a 10% drawdown (Calmar 3.0) is far better than one returning 50% with a 40% drawdown (Calmar 1.25). BacktestHub shows Calmar ratio, Sharpe ratio, Sortino ratio, and max drawdown duration in every backtest result.