Almost every RAW file requires some degree of sharpening to counter the effect of blurring that occurs at some stage of image capture or image processing. But when do you apply the sharpening? In Camera Raw or later in Photoshop? The answer isn't as straightforward as you might think. The fact is, there are compelling reasons to apply some sharpening to your RAW file using Camera Raw. There are also compelling reasons to turn off sharpening in Camera Raw, wait until your RAW file is open in Photoshop, and then apply sharpening via the new Smart Sharpen filter or one of the many third-party sharpening tools. It really depends on what you want: optimal workflow or ultimate flexibility and user control.
To sort through some of the misunderstanding about when and how to apply sharpening, I find it useful to break sharpening down into three general categories, applied sequentially in the order listed here:
Since we're talking about processing RAW files, I'm going to emphasize capture sharpening.
Capture sharpening is best understood by looking at an image with no sharpening applied. For example, look at Figure 1. The photo was taken with a Fuji FinePix S3 Pro SLR using a very high-end Nikon lens for optimal sharpness. It was shot at f/8 at 1/250th of second and carefully focused. I used the Camera Raw sharpening slider to turn sharpening completely off, and the resulting image is not an accurate representation of the scene as I shot it. Also, it doesn't do the equipment I used justice.

Figure 1: An image in need of sharpening.
Ok, so we agree this image requires sharpening, but what's the best way to do it?
I recommend using the sharpen feature in Camera Raw whenever you are processing large numbers of RAW files, or when speed is an issue and you simply want to create an image that appears sharp on a monitor. I say this knowing full well that you'll likely need to use other sharpening methods to apply Cosmetic or Output sharpening at a later point. I recommend using the Smart Sharpen feature in Photoshop if you have a problematic image that Adobe Camera Raw sharpening doesn't improve, or if you have the time and desire to perfect a particularly special image. (The Photoshop Smart Sharpen filter can also be used effectively for both Cosmetic and Output sharpening.) For this example, let's use Camera Raw.
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A sharpening value is automatically applied to a RAW file when you open it in Camera Raw for the first time. More often than not, the default Camera Raw sharpen setting works pretty darn well. There are good reasons for this. First, Camera Raw automatically applies a sharpening factor based on relevant data specific to a particular digital camera. Second, sharpening occurs only in the luminous channel, thereby reducing the chance of unwanted artifacts. Third, Thomas Knoll, a certified genius and creator of Photoshop, built the Camera Raw sharpen algorithm from scratch.
Of course, if you have the time or inclination, you can tweak the Camera Raw sharpen settings and apply your custom settings to other images taken with the same digital camera.
For an example of how to adjust the sharpness setting, I'll use the image in Figure 2, which has a combination of detail (trees) and continuous tone (sky). I want sharp, clearly defined branches, but I also want to avoid adding noise or artifacts to the sky.

Figure 2: I want to define the branches without adding noise to the sky.

Figure 3: I zoom in on a section that has both detail and continuous tone.

Figure 4: The Camera Raw Detail tab.

Figure 5: I start with the Sharpness slider set to 0.
Remember, when Preview is deselected you see a representation of your image determined by Camera Raw settings applied when the file first opened and before you changed anything. This means if Sharpening is set to 25 at Camera Raw startup, then when preview is deselected you are actually viewing your image with some sharpening applied.

Figure 6: I move the slider all the way to 100 to get a sense of the other extreme.

Figure 7: I finally arrived at 40 for the right balance.
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You can set Camera Raw to apply sharpening to the preview images only. However, when you open the image in Photoshop, the image will open with no sharpening applied. This allows you to see the effects of sharpening on your other Camera Raw adjustments. To do this:

Figure 8: The Camera Raw Preferences dialog box.
For some images, such as the moonscape shown in Figure 9, you can use Camera Raw's Luminance Smoothing controls to diminish artifacts caused by over sharpening, or, as in this case, a combination of sharpening and a high 800 ISO.

Figure 9: Luminance Smoothing can reduce the effects of over sharpening.
To do this:

Figure 10: The right balance found with the Luminance Smoothing slider.
Mikkel Aaland is a professional photographer whose pioneering work in digital photography dates back to 1981. He is the author of nine books including the bestselling Photoshop Elements Solutions and O'Reilly's acclaimed Photoshop Lightroom Adventure. Visit his website at http://www.shooting-digital.com.
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