Calculation and mechanics
The denominator is the so-called downside deviation. For every period it is checked how far the return lies below the set target. Negative deviations are squared, periods above the target enter as zero. The square root is then taken of the average of these values. The target is often zero or a set minimum return.
With daily data the Sortino ratio is usually annualized with the square root of about 252 trading days. As with the Sharpe ratio, this requires an observation for every trading day. A strategy with strong positive swings but comparatively small or rare negative deviations can therefore show a clearly higher Sortino ratio than Sharpe ratio.
If the period contains no observation below the target, the downside deviation is zero and the Sortino ratio is mathematically undefined.
Sortino ratio = (avg return - target) / downside deviation x sqrt(252)
Distinction
With the standard deviation the Sharpe ratio takes both positive and negative swings into account. The Sortino ratio instead only looks at deviations below the set target.
A clearly higher Sortino ratio can indicate that a large part of the total volatility lies on the positive side. When both metrics are close to each other, total volatility and downside risk differ less. This does not, however, directly imply a symmetric distribution of results.
Neither metric shows how large a single decline actually was. The Max drawdown, for example, serves that purpose.
Related terms
- Sharpe ratio (Reward-to-variability ratio)
- Calmar ratio (Drawdown ratio)
- Max drawdown (Maximum drawdown, MDD, time in drawdown)
- Expectancy (Average result per trade, expected value)
All market and analytical information is provided for educational and analytical purposes only and does not constitute investment advice or a trading recommendation.