Sortino ratio

The Sortino ratio measures return earned per unit of downside risk, refining the sharpe ratio by counting only volatility that comes from returns falling below a minimum acceptable threshold, often zero or the risk-free rate. Upside swings, which most investors do not consider "risk," are excluded from the penalty.

It is calculated as (Rp - MAR) / σd, where Rp is the portfolio return, MAR is the minimum acceptable return, and σd is the downside deviation — the standard deviation of only the returns that fall below the MAR. This differs from the Sharpe ratio's denominator, which uses total standard deviation regardless of direction.

Practitioners favor the Sortino ratio for strategies with asymmetric return profiles, such as option-selling or trend-following strategies that produce many small gains and occasional large ones, where the Sharpe ratio would unfairly penalize the upside variance. A common pitfall is comparing Sortino ratios calculated with different MAR assumptions, which makes the numbers non-comparable across funds; another is that with only a small sample of below-threshold returns, σd can be estimated unreliably. It is often reported alongside maximum drawdown and value at risk for a fuller picture of downside risk.