Investing Doesn’t Have to be Gambling Pt. 2

It woud be unfair of me to proceed to far into my explination without first ensure all technical terms are defined. What I would like to do with this post is then outline and defend a few of those terms. I’ll begin with a brief discussion related to poker terminology. Let’s get started shall we?

If you are at all aware of the tournament poker scene you’ve likely heard a multitude of slang terms thrown around, things such as “the nuts”, “the rocks”, “lightning in a bottle”, “rags”, and so on. These terms provide a great deal of information to those who know and understand them. Here are some definitions:

The Nuts: The statiscally best hand you can have at the time given the information available. For exaple, if the cards 8S,9D,7H lands on the flop and you are holding a 10 and a Jack, then you currently have the best hand available. However because there are two cards remaining there is still the possibility for you to lose.

The Rocks: This term is used for the best hand available regardless of the information you have. Unlike the nuts this hand has no cards that can be revealed to beat it. In most cases something like four aces fits; in all cases however a royal flush is the go to example.

Rags: This term refers to hands the are statistically bad and require a large number of things to go in your favor in order to win. Strong examples are high/low off-suit or the go to hand of 2-7 off suit.

Lightning in a Bottle: This phrase is used when you hand of rags does in fact work out and pay off for you.

Wired “X”: X here is a place holder for any one of the card types in a deck (from 2-ace). The term wired means that you are beginning a hand with a pair of that card, which gives you a statistical advantage over all non paired hands.

So what does all that matter? Primarily as I progress through this work I will often refer to a stock by a hand or type from poker as a way to illustrate its relative strength or weakness. By understanding basic tenants of the game you will better be able to understand what I mean or why I classify things the way I do. For example, when I refer to a stock as rags or wired kings, that can provide an indication of the quality of the stock.

Now that we have a little bit of lingo under our belts, let us outline in a slightly more useful way how I will be grouping stocks through the analogy of poker hands. There are for our purposes six types of hands in hold’em poker: Rags, Low Suited Connectors, Low Pairs, Mid Pairs, Top Tens, and hype hands. Let us take a look at what each of these entails.

Rags: As mentioned earlier in poker “Rags” are hands that are statistically unlikely to win due to their relation to other hand types. In the world of stocks it isn’t much different. Stocks which carry a multitude of problems such as small market cap, low or negative profit margins and high debt/equity ratios are stocks that while you may get lucky more often than not you will lose big on these. A few examples would include things like Zynga, or tiny tech companies/up and coming pharmaceuticals.

Low Suited Connectors: In poker these are hands such as 2/3 or 3/4 of the same suit. While on the face if it they seem similar to rags, these hands have a very high upside. In tournament poker making a hand with these cards can break an opponent as they are very hard to get a read on or see coming. In the world of stocks they are very much the same. Small companies who provide a revolutionary product or have the potential for extreme growth can give you a large payday for a seemingly small ante. A few examples would be companies like Ford, Southwest Airlines, or Bank of America. the reason why these are preferable is because they have solid financials and lots of opportunity for growth. In those specific examples they even provide a dividend which gives you added benefits for you relatively small investment.

Low Pairs: In poker a wired pair is considered low if it 7/7 or less. These are often solid plays in which you’re likely to win a hand (if played correctly) but they tend to have smaller payouts. In stocks this would fall into the scope of your typical dividend payers. Things such as Coca ~Cola, Pfizer, or Vodafone. These stocks will likely never sway more than a few points above or below you purchase point but they provide stability and dividends which can grow a portfolio well if, like in poker, they are played correctly.

Medium Pairs: Medium pairs are very similar to low pairs except they are often a little more risky (in poker they can often be a trap, forcing you to stay in and lose to a top ten hand). Often in stocks these would be this like known or established tech companies or oil/energy plays. A few examples would be Conoco Philips, Apple, or Exxon Mobile.

You may wonder why apple is here and not a top ten, its because of the swings and the ability to lose big even though it seems like a solid play. Companies like Apple are more often than not, traps.

Top Tens: For poker sake these are simply the Top Ten best hands statistically available to start with. Things such as A/A or K/K, which are likely to win you every hand you play them. The only problem with them is they are often easily found out and the payouts are not all that large. This tends to be the case for the best stocks as well. Companies such as Google, Amazon, or Mcdonald’s. What makes these companies so good is a multitude of things. They tend to excel in all metrics and have done so for an extended period of time. The only downfall is they usually come with a high price entry point and as such move very little compared to that point.hands

Hype Hands: Lastly, I want to briefly discuss the odd balls. The are hand in poker that usually have a name and someone always considers lucky. Things such as Motown (J/5) or the Brunson (10/2 off-suit). While these hands have done well for some at one point or another they are statistically more like rags than anything else. As such in both poker and stocks avoid these at all costs. I think a few solid examples are companies like Facebook, Best Buy, and Amd.

 

I think I will end this post here. Next time we’ll begin the discussion on exulting stocks, chasing the correct metrics and further filling out the analogy. Thanks for reading.     

       -D

 

 

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