Sortino Ratio: A Better Measure of Risk-Adjusted Return
By Daniel Chau
Founder, NeuroBacktest
Learn why the Sortino ratio is often more useful than the Sharpe ratio for traders who care about downside risk.
The Sortino ratio is a risk-adjusted performance metric that focuses on downside risk rather than total volatility. For strategies with asymmetric return profiles, it often tells a more accurate story than the Sharpe ratio.
Why Downside Volatility Matters
Traders do not lose sleep over upside volatility. The Sharpe ratio penalizes both large gains and large losses equally, which can make a trend-following strategy with big winners look riskier than it feels in practice. The Sortino ratio removes upside volatility from the denominator.
How to Calculate It
Subtract the risk-free rate from average return, then divide by the standard deviation of negative returns. A Sortino ratio above 2 is generally considered strong. Compare it to the Sharpe ratio on the same backtest to see whether upside swings are distorting your risk assessment.
When to Prefer Sortino
Use Sortino for strategies that intentionally target asymmetric payoffs, such as trend following, options selling, or momentum systems. For symmetric strategies, Sharpe and Sortino will be similar.
Frequently Asked Questions
What is the Sortino ratio?▼
The Sortino ratio measures risk-adjusted return using only downside volatility. Unlike the Sharpe ratio, it does not penalize upside volatility.
How is Sortino different from Sharpe?▼
The Sharpe ratio divides excess return by total volatility. The Sortino ratio divides excess return by downside deviation, making it more relevant for strategies with asymmetric returns.
When should I use the Sortino ratio?▼
Use Sortino when your strategy has large upward moves that you do not want to penalize, such as trend following or options strategies.