Sortino Ratio
Why all volatility isn't created equal: Measuring the risk that actually matters.
Quick Definition
The popular **Sharpe Ratio** punishes a portfolio for any volatility—even if that volatility is to the upside (gains). The **Sortino Ratio** fixes this by only penalizing "bad" volatility: the drops that actually cause stress and capital loss.
Sharpe vs. Sortino
If a stock goes up 20% every month, its Sharpe Ratio will be lower because it's "volatile." The Sortino Ratio, however, would be very high because there is no **Downside Deviation**. For serious investors, Sortino is often a more realistic measure of risk-adjusted performance.
Downside Deviation
Unlike standard deviation, this only accounts for returns that fall below a specific target or "minimum acceptable return."
The Formula
(R - T) / Downside Deviation
R = Portfolio Return, T = Target/Risk-free rate
When to use it
Use the Sortino Ratio when comparing aggressive growth strategies. A high Sortino Ratio indicates that the portfolio achieved its returns without significant "drawdown pain." It's the ultimate metric for those who want to sleep well during market corrections.
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