The OODA loop - A simple approach for how traders should behave

Traders are faced with making fast decisions under uncertainty with limited information. This is not different than what an air force fighter pilot will face when engaged in combat. He has to process information quickly and learn to decide and act just as quickly. Speed and success are difference between life and death. This necessity to act fast is why the thinking of John Boyd, the air combat strategist, is applicable for helping any trader or manager who has to make quick decisions as new information enters the market. I think Boyd's action loop is a good foundational approach to developing research for any systematic trader. The loop is called OODA - Observe, Orient, Decide, and Act. It is simple enough and may seem obvious, but that is what makes it so effective. Keep it simple and something that can be ingrained in thinking.

Like any good research process, the first step is to observe the environment and understand the new unfolding information that is entering the market. Decisions cannot be made in a vacuum. The second step orients or places the observation in context. Facts or observations are not enough. The information has to be placed within the overall market conditions such as central bank behavior or the business cycle. After placing observations in context, the next step is deciding what action should be taken. This is the hypothesis or the form of the proposed outcome of the new information. The final part of the loop is to act on the decisions. Forecasting or deciding without action is wasted effort.

Of course, each of these steps will be fed back through the loop. Action taken will generate new observations which have to be stepped through the loop. If this process is repeated enough times with the same type of information, systematic or disciplined action rules can be created. This is the foundation of any money management model. From following repeated loops and feedback come success. This OODA loop can be applied to past data as the foundation for back-testing. The skill of a trader is related to his ability to follow these steps and do them better than his peers.