The Sharpe ratio in plain language
The Sharpe ratio compares excess return — the return above a so-called risk-free rate — with the total volatility of returns. That volatility includes upward and downward movements. A higher ratio means that historical return was greater per unit of measured variability.
Educational example: if two simulations returned 10%, Sharpe will generally favour the one with the steadier path. It can nevertheless penalize a strong gain because that gain also increases volatility, even though the movement helped the investor.
The Sortino ratio focuses on harmful risk
The Sortino ratio resembles Sharpe, but its denominator uses downside deviation: it focuses on returns below a selected threshold instead of every movement. It therefore asks a more targeted question: how much excess return was earned for each unit of unwanted downside?
Sortino may feel more intuitive when an investor does not regard strong gains as risk. Its value still depends on the chosen minimum threshold, observation frequency and analysis period.
Sharpe or Sortino: which one should you examine?
Sharpe provides a broad view of return consistency; Sortino isolates downside risk more closely. They are complementary. A sound comparison uses the same period, data frequency, reference rate and fee assumptions.
No threshold automatically turns a strategy into a good or bad choice. A small sample, an unusually favourable period, asymmetric returns or overfitting can make either ratio misleading.
How AInvestor makes the ratios educational
In the Strategy Lab, a ratio should appear beside return, maximum drawdown, the market benchmark, simulated fees and the tested period. Tooltips define the terms and explain what can move the measure up or down.
The purpose is to explore a simulation and understand its trade-offs, not to issue a buy, hold or sell recommendation. Historical and simulated results never guarantee future outcomes.