Allying a Military Model to Financial Chaos

Published on INFORMS OR/MS Today (Joseph Byrum)

Developed for jet fighter pilots, four-stage OODA Loop can help financial analysts manage overwhelming flow of information.

Financial analysts often face overwhelming incoming information, and the decisions they make can have life-changing impacts on clients.

The military can take credit for creating some of the most important technological advances in our lifetime. Everything from GPS navigation to the Internet itself were designed at first to meet specific national defense objectives. But the military isn’t just an incubator for useful gadgets. The insights developed by military strategists can be of great use in financial analysis.

When lives are on the line, only the best, battle-tested ideas will do.

Financial analysts, of course, are far from the line of fire, but the decisions they make can have life-changing impacts on their clients. So why not use the best available tools to help those clients achieve their financial goals?

One of the most useful concepts is taught to every fighter pilot as a way to manage the overwhelming flow of information found in the modern combat environment. It’s called the OODA Loop, which stands for Observe-Orient-Decide-Act. U.S. Air Force Col. John Boyd came up with the concept as a way of managing uncertainty and delivering success. It has a great deal of relevance to the work of a financial analyst.

A fighter pilot must make split-second decisions within a constantly changing battlespace. For every move made, opponents make counter-moves at speeds up to twice the speed of sound. Things happen so fast that it’s easy for the pilot to become lost in the chaos and stress of the situation. Col. Boyd decided to break down what was happening into four stages. This allowed him to dissect the way pilots processed information so that he could see what they were doing and, ultimately, hone their skills. The idea was to refine the mental concepts pilots used to represent observed reality so that they would be able to evaluate risks and act more swiftly. As speed provides a critical edge on the battlefield, the pilot who makes the right choice first gains the initiative and the best chance at victory.

Col. Boyd’s original diagram lays out his OODA Loop idea (Figure 1). It consists of four stages that describe a way of thinking about observed reality, managing uncertainty and making informed decisions. 

Figure 1: Col. John Boyd’s original OODA Loop. 

The Financial OODA Loop

Stage 1: Observation. In the first step, we gather as much information as possible within applicable time constraints. As the situation is constantly changing, the data at hand will likely be incomplete and imprecise. In battle, this is called the fog of war. What matters most here is observing the world as it is, rather than attempting to describe the world as we might prefer it to be. That means we must set aside preconceived notions and take in the raw data.

Where the fighter pilot has only a matter of seconds to consult instruments and glance at the sky above to gain situational awareness, analysts have the luxury of a more relaxed environment. They can track earnings and expenses. They can review press coverage and read financial statements. They can consult the hard numbers that measure financial markets are most important – the index levels, interest rates, inflation gauges and so on.

Think of this as the “just the facts” stage. The analyst must avoid seeking out data points that bolster existing opinions. The goal here is to see reality, not interpret it or pass judgment. Opinion-forming takes place in the next stage. 

Stage 2: Orientation. This is the critical step in which we evaluate the data and form judgments. We begin by taking stock of what we know – the observations thus far, and the relative value of each in terms of how much we trust them. The same observations can be seen from several different perspectives, and analysts each apply their own unique experience and insight to the situation.

Col. Boyd explained that these personal information filters are our “genetic heritage, cultural traditions, and previous experiences.” This is why diverse teams provide important insight, as one individual can notice something another overlooks.

In this stage, it is important to challenge assumptions. Instead of presuming, for example, that past performance will determine future results, the idea is to focus on the causes of performance gains.

This is also the place where we must take stock of what we don’t know. The fighter pilot is always “checking six” in case an unseen opponent is lurking behind. The best way to avoid a financial surprise is to consider what we need to know for a complete understanding of the situation, so that, when we lack that information, we can seek alternatives to fill in the knowledge gap. Often, we will lack every piece of information needed to make a perfect decision. That means the Decision stage will be impaired – but at least we will know that going in.

Stage 3: Decision. Here, we take the options uncovered in the Orientation stage and go with the one that seems most likely to work in the given circumstances. Such choices are not made in a vacuum. There are command structures, missions, strategies and parameters that influence the choice. Those command structures are higher levels of the organization that have decision stages of their own.

It’s not about making a perfect choice since our information will be imperfect. We settle for the “hypothesis” that we think will work. Col. Boyd refers to this stage as a hypothesis because it’s something that will need to be put to the test. That is, we’ll want to validate whether the decision is the right one in the next stage. 

Stage 4: Action. Pulling the trigger – or more accurately, executing the plan developed in the Decision stage – is just the start of the Action phase. This is also the place for validation. That is, we continuously monitor the effect of our actions here.

Not every attempt is going to be successful. We might, for example, increase holdings of a particular stock over time, seeking an average purchase price below a target share price. Once the first buy is made, we’ll need to keep monitoring. If the share price rises too high, we’ll have to stop and reevaluate.

That’s why Col. Boyd also refers to this as the “Test” phase. The validation process he described creates data that will be fed into the Observation stage as we take our second run through the OODA Loop. 

Looping

The financial landscape is always evolving, and as it does, the investment approaches that are going to work will also change. We have to adjust our decisions to suit the landscape as it changes over time. Choices that wouldn’t have worked in year one might work in year four, or week four or even hour four.

Now in our next trip around the Loop, we observe how our actions have influenced the data we collected in the Observation stage. We use this information to update our overview out what’s happening. What the Loop does is force us to reconsider our models as information changes. Validation is the most commonly overlooked step in financial strategies. The key is realizing that the old way isn’t working and it’s time for a new approach.

Armed with this new information, we take stock of what we know in the next Orientation stage. We note our confidence level in that information and review what we ought to learn in the future.

In the second Decision stage, we decide whether the current course of action is on track or if additional action is needed. We drop what’s not working in favor of an alternate action based on the best available information gathered in the Observation stage. Finally, the Action stage is where the decisions are executed, which will feed performance information to the Observation stage so that the Loop can be repeated, as necessary. 

Conclusion

The OODA loop isn’t just a conceptual tool limited to use by solo fighter pilots on urgent missions. The same conceptual framework equally applies to large organizations that cycle through observations, form hypotheses, make decisions and take action. By now you’ve probably realized its uses are not limited to finance, either.

The OODA Loop is a way of thinking – for everyone. It’s about questioning beliefs in the light of new facts to come up with new solutions. In short, it’s a road map for success in any endeavor requiring strategic planning.

The OODA Loop teaches us to apply the information we have to our own circumstances, then decide how to adjust our orientation to achieve our goals. The genius of the OODA Loop is that, when properly implemented, it corrects the inherent biases of the analyst that usually lead to bad decisions. The system forces us to confront the raw data and re-evaluate previously held positions. It’s a learning system, and as the system learns, so does the user. Born in war, these techniques are worthwhile for anyone involved in peacetime analytical pursuits.