What is Sortino Ratio?
The Sortino Ratio is a variation of the Sharpe Ratio that uses downside deviation instead of total standard deviation in the denominator. The key insight is that investors do not dislike upside volatility: only downside risk should be penalised. Downside deviation measures only the standard deviation of returns that fall below a target return (typically zero or the risk-free rate). As a result, a strategy that has large positive swings but few negative swings will score much better on Sortino than on Sharpe. The Sortino Ratio is particularly useful for evaluating asymmetric strategies like options selling, trend following, or strategies with occasional large gains.
Formula
Sortino Ratio = (Portfolio Return − Target Return) / Downside Deviation
Downside Deviation = √[ Σ min(0, r_i − T)² / n ]
T = target/minimum acceptable return (usually 0%)
r_i = return in period i
n = number of periods
Calculator
How to Use
- 1Enter portfolio return: Annualised return of the strategy.
- 2Set target return: Usually 0% or the risk-free rate. Returns below this are considered negative outcomes.
- 3Enter downside deviation: The annualised standard deviation of returns below the target. Requires a series of period returns to compute manually.
- 4Interpret: Higher is better. Sortino > Sharpe implies the strategy has more upside than downside volatility, which is a good sign.
Worked Example
Example: Options income strategy
Return
18%
Target
0%
Downside Dev
6%
Sortino = (18% - 0%) / 6% = 3.0, which is excellent. If the Sharpe of the same strategy is 1.5 (using total StdDev of 12%), the difference reveals that roughly half the volatility is upside, consistent with an income strategy that profits in most conditions but occasionally has a large loss month.