Sortino Ratio
The Sortino ratio is excess return divided by downside deviation (only the standard deviation of negative returns). It's a refinement of the Sharpe ratio that doesn't penalise a strategy for big upside moves.
Why it's better than Sharpe
Sharpe penalises a strategy that has occasional huge winners just as much as one with consistent losses. Sortino only counts the downside — which is what investors actually care about. A strategy that's "too volatile" because it produced +30% months has a low Sharpe and a high Sortino.
Formula
Sortino = (R_p − R_f) / σ_d, where σ_d is the standard deviation of returns *below* the target return (often zero or the risk-free rate).
When to use which
- Use Sharpe for benchmarking against indices and traditional strategies.
- Use Sortino for trend-following, options, and crypto strategies where upside is fat-tailed.
Related Terms
Sharpe Ratio
The Sharpe ratio measures excess return per unit of volatility — the most-cited risk-adjusted performance metric in finance.
Drawdown
Drawdown is the percentage decline from a peak in your account equity to the next trough — the most important number in risk management.
Profit Factor
Profit factor is gross winning trades divided by gross losing trades — the single quickest test of whether a strategy has any real edge at all.
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