Risk & Money ManagementDownside Risk-Adjusted Return
Sortino Ratio
A variant of the Sharpe ratio that divides excess return by downside deviation only, ignoring upside volatility.
What Sortino Ratio means
The Sortino ratio keeps the numerator of the Sharpe ratio, return above a chosen threshold, but replaces the denominator with downside deviation, which is the standard deviation calculated using only the returns that fall below that threshold. The threshold, called the minimum acceptable return, is commonly set to zero or to the risk-free rate. The reasoning is that traders do not experience upside variability as risk, so measuring it as such understates the quality of strategies that produce occasional large gains.
Because the denominator excludes profitable outliers, the Sortino ratio is normally higher than the Sharpe ratio for the same return series, and the gap between them is itself informative about the shape of the distribution. Two caveats apply. The downside sample contains fewer observations, so the estimate is noisier and less stable than a Sharpe ratio built on the full series. And because the minimum acceptable return is a free choice, ratios from different sources are frequently not comparable without checking the convention used.
Worked example
A strategy with 9 percent excess return and a downside deviation of 6 percent scores a Sortino ratio of 1.5, against a Sharpe ratio of 0.6 once its full 15 percent standard deviation is used instead.
Related terms
- Sharpe RatioA risk-adjusted return measure: return in excess of the risk-free rate divided by the standard deviation of returns.
- Calmar RatioAnnualised return divided by maximum drawdown over the same window, conventionally measured across three years.
- VolatilityThe magnitude of price fluctuation over a period, usually measured as the standard deviation of returns or as an average range.
- DrawdownThe decline from a peak in account equity to a subsequent trough, usually stated as a percentage of the peak.
- ExpectancyThe average profit or loss a system produces per trade given its win rate and its average win and loss sizes.
Frequently asked questions
What does Sortino Ratio mean in forex trading?
A variant of the Sharpe ratio that divides excess return by downside deviation only, ignoring upside volatility.
How does Sortino Ratio work in practice?
Because the denominator excludes profitable outliers, the Sortino ratio is normally higher than the Sharpe ratio for the same return series, and the gap between them is itself informative about the shape of the distribution. Two caveats apply. The downside sample contains fewer observations, so the estimate is noisier and less stable than a Sharpe ratio built on the full series. And because the minimum acceptable return is a free choice, ratios from different sources are frequently not comparable without checking the convention used.
What is an example of Sortino Ratio?
A strategy with 9 percent excess return and a downside deviation of 6 percent scores a Sortino ratio of 1.5, against a Sharpe ratio of 0.6 once its full 15 percent standard deviation is used instead.
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