Using Sharpe Ratio Thresholds as a Backtest Screening Heuristic

Summary

This note offers informal Sharpe-ratio thresholds for screening strategies under a stated evaluation context: a single strategy rotating half-capital among at least three stocks, with million-level capacity and a backtest covering roughly three years. It treats a Sharpe above one as a possible candidate threshold and describes 1.5 as strong. It cautions that much higher backtest Sharpes may reflect repeated curve fitting rather than durable performance, especially when researchers keep adjusting a strategy to improve its historical return curve.

The note also recommends judging a strategy alongside monthly win rate, monthly payoff ratio, annualized absolute return, and drawdown. It gives no underlying sample, statistical analysis, or evidence for its stated proportions of overfit strategies, so those figures are best read as the author's rule of thumb rather than general findings. It further warns that short backtests can produce very high Sharpe values, reinforcing the need to consider test duration and broader evidence before selecting a strategy.

Key ideas

• The note treats Sharpe as one component of a broader strategy evaluation framework.
• Its candidate thresholds assume a specific multi-stock rotation setup, capital capacity, and multi-year backtest context.
• It warns that repeated tuning to improve historical performance can create overfitting.
• It recommends considering win rate, payoff ratio, annualized return, and drawdown alongside Sharpe.
• The stated overfitting proportions are unsupported by evidence in the document.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.