Sortino Ratio

The Sortino Ratio is a variation of the Sharpe Ratio designed to address one of its main criticisms: the Sharpe Ratio treats upside and downside volatility identically, even though investors generally welcome large positive months and only worry about large negative ones.

Instead of dividing excess return by total standard deviation, the Sortino Ratio divides it by "downside deviation" — a measure that only counts the volatility of returns that fall below a minimum acceptable threshold (often zero, or the risk-free rate). A strategy that has a few extremely strong up months and otherwise steady, small losses will look worse under the Sharpe Ratio than under the Sortino Ratio, because the Sharpe Ratio penalizes that upside volatility as if it were a negative.

Because of this, the Sortino Ratio is often considered a more intuitive measure of "risk-adjusted return" from an investor's actual point of view: it only cares about the volatility you experience as a loss, not the volatility that comes from unusually good months.