Sortino Ratio
A variation of the Sharpe ratio that differentiates harmful volatility from total volatility by using downside deviation instead of total standard deviation.
Detailed Financial & Mathematical Context
The Sortino ratio modifies the Sharpe ratio by dividing excess portfolio return by downside semi-variance. This ensures that large positive jumps in equity are not penalized as risk.
Video Explainer & Key Moments
Discover why professional quant funds use the Sortino Ratio to evaluate asymmetric strategies like trend-following and breakout models.
Frequently Asked Questions
What is the Sortino ratio used for in trading?
The Sortino ratio is used to measure a strategy risk-adjusted return by focusing exclusively on downside volatility (bad risk), preventing high positive return spikes from lowering the score.
What is considered a good Sortino ratio?
A Sortino ratio of 2.0 or higher is generally considered good by institutional investors, while ratios above 3.0 indicate exceptional performance with tightly controlled downside risk.
What is downside deviation in the Sortino ratio?
Downside deviation (or downside semi-variance) calculates the standard deviation of only those negative returns that fall below a minimum acceptable return (MAR), usually set to 0% or the risk-free rate.
When should you use the Sortino ratio instead of the Sharpe ratio?
You should use the Sortino ratio when analyzing non-normally distributed strategies, such as trend following, momentum breakouts, or asymmetric options strategies where upside volatility is desirable.
Can a strategy have a low Sharpe ratio but a high Sortino ratio?
Yes. A strategy with large, explosive positive winning trades and small, steady losses will have high total variance (lower Sharpe) but very low downside variance (high Sortino).
Related Concepts
Comprehension Check
Why do quantitative fund managers often prefer the Sortino ratio over the Sharpe ratio?