What it means
Sortino ratio is a risk-adjusted return metric similar to Sharpe but using only downside deviation (volatility of negative returns) rather than total volatility in the denominator. Formula: (Return - Risk-free rate) / Downside deviation. Sortino > Sharpe always (downside deviation ≤ total deviation). For strategies with asymmetric returns (positive skew — trend following, options selling, momentum), Sortino captures risk-adjusted performance more honestly than Sharpe.
Why it matters
Sharpe penalizes upside volatility as if it were risk — which it isn't. A strategy with huge positive surprises and small negative ones looks bad on Sharpe but great on Sortino. Trend-following systems and momentum strategies show this asymmetry; Sortino is the better metric for evaluating them.
How to use it
Compute Sortino on at least 50 trades or 6+ months of data. Compare to Sharpe — large Sortino-Sharpe gap indicates asymmetric returns (right-tailed = positive). Use Sortino as primary metric for trend-following and momentum strategies; Sharpe for mean-reverting strategies where the asymmetry is smaller.
Want a worked example or a deeper dive? Ask Rocky how this concept applies to your specific watchlist or trade idea.
Ask Rocky