Sortino ratio explained: downside risk adjusted return

By Ken Chigbo, Founder, KenMacro. Published 2026-05-13.

What is Sortino ratio?

The Sortino ratio is a risk adjusted performance metric developed by Frank Sortino as a refinement of the Sharpe ratio. It divides excess return over a minimum acceptable return by the downside deviation, which is the standard deviation calculated only from returns that fell below that threshold. By stripping out upside variance, it answers a sharper question: how much reward did the strategy deliver for each unit of harmful volatility it took on? The desk treats it as a cleaner lens on asymmetric return profiles, particularly trend following and options selling, where upside and downside distributions look nothing alike.

How traders use Sortino ratio

Retail systematic traders calculate the Sortino on monthly or daily equity curve returns when comparing strategies during backtesting. A strategy with a Sortino above 2 is generally considered strong, while readings below 1 suggest the reward is not compensating for downside risk. Institutional allocators use it when screening commodity trading advisors and hedge fund managers whose return streams are skewed, because Sharpe penalises the large positive months that define a good trend follower. The desk pairs Sortino with maximum drawdown and time-to-recovery, since a high Sortino can still mask brutal peak-to-trough excursions. It also reviews the minimum acceptable return assumption carefully, because setting it at zero versus the risk-free rate materially changes the output.

Worked example of the Sortino ratio

Suppose a strategy returns 12 percent annualised with a minimum acceptable return of 2 percent. Across the monthly return series, only the negative months are used to compute downside deviation, which comes out at 5 percent. The Sortino is therefore (12 minus 2) divided by 5, giving 2.0. By comparison, the same strategy might have a Sharpe of 1.1 because several large positive months inflated total standard deviation. The gap between the two ratios signals a positively skewed return distribution, typical of breakout or trend capture systems where winners run further than losers.

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Frequently asked

What is a good Sortino ratio for a trading strategy?

As a rough industry convention, a Sortino above 2 is considered strong, between 1 and 2 is acceptable, and below 1 suggests the strategy is not adequately rewarding its downside risk. These benchmarks vary by asset class and timeframe. Intraday strategies typically produce higher ratios than swing systems because of compounding effects in the calculation. Always compare like with like, using the same return frequency and minimum acceptable return assumption across candidates.

How does the Sortino ratio differ from the Sharpe ratio?

The Sharpe ratio uses total standard deviation in its denominator, penalising both upside and downside volatility equally. The Sortino ratio uses only downside deviation, calculated from returns below a minimum acceptable threshold. This matters because most traders view large positive months as a feature, not a bug. Sortino tends to flatter strategies with positively skewed returns, while Sharpe favours those with tight, symmetric return distributions like market-neutral or carry trades.

Can the Sortino ratio be negative?

Yes. When a strategy’s average return falls below the minimum acceptable return, the numerator becomes negative, producing a negative Sortino. This indicates the strategy is failing to clear its hurdle rate while still exposing capital to downside variance. The desk treats persistently negative Sortino readings as a clear signal to retire or rebuild the system, since no amount of position sizing can fix a structurally unprofitable edge.

What minimum acceptable return should I use?

Common choices include zero, the risk-free rate, or a target benchmark return. Using zero produces the most generous Sortino because any positive return counts as success. Using the risk-free rate aligns the ratio with opportunity cost thinking. Institutional users often set the minimum acceptable return at a benchmark such as the strategy’s stated hurdle. Whichever choice is made, apply it consistently across all strategies being compared, otherwise the rankings become meaningless.

Educational analysis only. Past performance does not guarantee future results. Manage risk against your own portfolio.