Sharpe Ratio Analysis
The Sharpe Ratio measures Bitcoin's risk-adjusted returns by comparing average returns to volatility. Using a 150-day rolling window with a 14-day SMA, this indicator identifies overbought (Sharpe SMA > 4) and oversold (Sharpe SMA < -2) market conditions, highlighting periods of exceptional performance and potential reversals.
Understanding the Sharpe Ratio
What is the Sharpe Ratio?
The Sharpe Ratio is a statistical measure that evaluates risk-adjusted returns by dividing the mean return by the standard deviation of returns. A higher Sharpe Ratio indicates better risk-adjusted performance. This indicator calculates the Sharpe Ratio using a 150-day rolling window: (Mean Return / Std Dev) × √365, providing an annualized view of Bitcoin's performance relative to its volatility.
Signal Generation and Smoothing
A 14-day Simple Moving Average (SMA) is applied to the Sharpe Ratio to smooth out daily fluctuations and generate clearer trading signals. This smoothing helps filter market noise while preserving significant trends. The SMA crosses above and below key thresholds to indicate overbought and oversold conditions, which historically precede market corrections or recoveries.
Overbought and Oversold Thresholds
When the Sharpe Ratio SMA exceeds 4, it signals exceptionally high risk-adjusted returns, often indicating market euphoria and increased probability of corrections. Conversely, when the SMA falls below -2, it reflects poor risk-adjusted performance typical of market downturns, historically presenting accumulation opportunities. The neutral zone between -2 and 4 represents balanced market conditions without extreme signals.
Historical Context and Application
With historical data from 2015 onwards, the Sharpe Ratio indicator captures Bitcoin's major market cycles. The logarithmic price scale visualization allows for clear pattern recognition across Bitcoin's entire price history. This indicator works best in conjunction with other technical and fundamental analysis tools, as it measures relative performance rather than absolute price movements. Past extreme readings have successfully identified major market tops and bottoms, though historical performance does not guarantee future results.