Sortino Ratio
A variation of the Sharpe ratio that only penalizes downside volatility, not upside swings.
The Sortino ratio is a refinement of the Sharpe ratio. Where Sharpe treats all volatility — both gains and losses — as risk, the Sortino ratio only counts downside deviation: the volatility that comes from losing trades and drawdowns.
This distinction matters for trading strategies with asymmetric return profiles, such as trend-following systems that occasionally post large winning trades. A high Sharpe ratio can understate how well-controlled a strategy's actual risk is if some of its 'volatility' is really just big wins.
Sortino Ratio = (Return − Risk-Free Rate) ÷ Downside Deviation
A breakout strategy with a few outsized winning trades might show a middling Sharpe ratio (because those big wins count as volatility) but a much stronger Sortino ratio, since the downside risk is genuinely low.
Why it matters
When comparing two algorithms with similar Sharpe ratios, the one with the higher Sortino ratio is generating its volatility mostly from winning trades rather than losing ones — a meaningfully better risk profile for most traders.