The OODA Loop – what traders can learn from a retired Top Gun instructor

Trading is like life.

All the little - and big - things that can impact your life can impact your trading. Or, more correctly all the little - and big - things that can impact your life DO impact your trading.  

So I've spent more than 20 years studying behavioural economics and finance in the hope to get a better understanding of how humans interact and, to be frank, figure out ways I can become a better trader.  

So I can make more money, more consistently.  

And when I work with traders what I find is that when I can take real world situations, processes, and strategies, and show how they can be applied to trading I usually enhance both the understanding and the efficacy of the thing we are working on.

Which is where this article about what traders can learn from a Top Gun instructor originated.

Recently, while reading an article  I stumbled upon at Business Insider I was struck by the applicability of the decision-making process retired Top Gun instructor David Berke used in his daily life, and in combat, for trading.

That process – the “OODA Loop” - was first developed by fighter pilot John Boyd during the Korean War when US pilots were theoretically outmatched in their hardware but still dominated the skies,

The acronym OODA refers to the elements of the decision Loop - Observe, Orient, Decide, and Act. 

I know readers, you aren't going "Mach II  with your hair on fire" - as Charlie said to Maverick in Top Gun. Nor, are we needing to constantly adjust to the intricacies of a dogfight that Boyd or Berke would have experienced in their careers.   

But just in those four words, in the acronym OODA, you can see why Berke told Business Insider "Every single thing you do in your life, every decision you make, is an OODA Loop". 

He is dead right. And the OODA Loop will work for trading too. 

Let's walk through how Berke said the OODA Loop works in practice.

Observe

Berke says you need to take in everything around you.

He says in a plane it's not "just the enemy pilot you’re facing off against. You’re also aware of each of the gauges in your cockpit, and you’re aware of your place in the sky".

It's not different with trading. 

A fundamentalist will have observe the lay of the land from a fundamental point of view. A chartist will have assimilated the technicals. 

But as the plane never has a fixed position unless it's on the ground and parked so in trading the asset I'm looking at - say forex - are also always moving. Fundamentals change, the charts change as prices move. Some levels are respected, some break.

As Berke says, we need to take in everything around us - even if that everything is just a chart. 

Orient

This is where you add "meaning to your observations". 

In his original OODA Loop Boyd "considered this the most crucial aspect of the Loop because it entails an awareness both of yourself and your opponent. When mastered, it allows you to predict outcomes".

This is the process that readers see me go through each day in my Overnight Markets Wrap and in my daily video. The research I do, both fundamental and technical, is how I orientate myself with the market. 

In Berke and Boyd's fighter pilot parlance this step towards orientation has 5 subprocesses which help orient their thinking.  

The first two - cultural traditions and genetic heritage - how you were trained and how you stack up against your opponent are not necessarily applicable for trading. 

But the other three - previous experience, analyses and synthesis, and new information - are directly applicable to traders, the markets, and the economy.  

Previous Experience is simply how similar scenarios have played out before. Think technical analysis - trend lines, Fibonacci levels, head and shoulders, cycles and so on. Or maybe fundamental analysis - tight labour markets, inflation, central bank policy, forex levels and so on. 

Analyses and Synthesis are exactly the part of the of the OODA process which ties the previous experience together to allow for the trading decision to be made. Essentially what have you studied and what did it teach you about the situation at hand. 

And of course the OODA Loop has to account for New Information as it becomes available or as it impacts the scenario you are looking at. 

Decide

Berke said he considers the decision phase of the Loop to be "art" where the first two steps are the "science". 

That he says is because "We’re not robot. If you take 100 people in the room and give them all the same information, you won’t get the same information". Indeed, that - as they say - is what makes a  market.

Even with all the information, some traders will be buyers and others sellers. But in my experience the key to the "decide" phase of the Loop

But in my experience, the key to the "decide" phase of the Loop - entries, stop losses, position sizing, and so on - is that it must itself have a clear process to decide, pull the trigger, on all these variables on any given trade.  

Act

Like pulling the trigger to execute a trade, Berke says this is often the most difficult for people because they want to over analyse things. To make sure they have all the information and make the ideal decision before they enact it. 

"You’re not going to have 100% of the information you want,” he said. You need to decide however much information is acceptable before moving forward, and you can’t be a perfectionist if you want to best your opponent," he said.

From a trading perspective, you can see how the Observe, Orient, and Decide steps can be combined in the process to overcome this need for perfect knowledge before acting. For me, it is a combination of the inputs into my system that then drive the decision to act once the parameters for a trade are met. 

The Loop

Each of the 4 elements of the OODA Loop is connected. And the Loop is repeated constantly with feedback into the Loop which then impacts the next step and the Loop overall.  

“As you’re pulling your aeroplane towards the other guy and you’re selecting a weapon, and you’re looping or rolling or doing those things, I promise you the other guy is responding to that. He’s moving his aeroplane in relation to you. And you know what you’re doing right then? You’re observing. And then orienting, and then making another decision,” Berke said.

It's the same with feedback from the market or the economy.  

Decision making, and acting on those decisions, is the key to trading.

Of course, it helps if the decisions are good ones. But the OODA Loop can provide the framework to help traders make good decisions.

Have a great day's trading and don't forget I'm on Twitter @gregorymckenna.

Greg McKenna

Chief Market Strategist

gregmckenna.com.au

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