These are the tried and true money management rules for traders, given to us by the greatest trader of all time.  I felt obligated to share these points as I read through them- even though I am more of a long term investor.

I have always said that there are many ways to make money in the market and that you can always learn from others.  That said, please take these words of Mr. Livermore and figure out what they mean to you and your investing or trading plan.

1) Don’t lose money.

Don’t lose your stake. A speculator without cash is like a store-owner with no inventory. Cash is your inventory, your lifeline, and your best friend. Without cash, you are out of business. Don’t lose your line.
There is no place in speculating for hoping, for guessing, for fear, for greed, for emotions. The tape tells the truth.

2) Always establish a stop.

A successful speculator must set a firm stop before making a trade and must never sustain a loss of more than 10 percent of invested capital.
I have also learned that when your broker calls you and tells you he needs more money for a margin requirement on a stock that is declining, tell him to sell out the position. When you buy a stock at 50 and it goes to 45, do not buy more in order to average out your price. The stock has not done what you predicted; that is enough of an indication that your judgment was wrong. Take your losses quickly and get out.

Remember, never meet a margin call, and never average losses.
Many times I would close out a position before suffering a 10 percent loss. I did this simply because the stock was not acting right from the start. Often my instincts would whisper to me:J.L., this stock has a malaise, it is a lagging dullard. It just does not feel right, and I would sell out of my position in the blink of an eye.

I absolutely believe that price movement patterns are repeated and appear over and over with slight variations. This is because humans drive the stocks, and human nature never changes.

Take your losses quickly. Easy to say, but hard to do.

3) Keep cash in reserve.

The successful speculator must always have cash in reserve for exactly the right moment. There is a never-ending stream of opportunities in the stock market and, if you miss a good opportunity, wait a little while, be patient, and another one will come along. Don’t reach for a trade, all the conditions for a good trade must be on your side. Remember, you do not have to be in the market all the time.

The desire to always be in the game is one of the speculator’s greatest hazards.
When playing the stock market, there are times when your money should be waiting on the sidelines in cash waiting to come into play. Time is not money “ time is time, and money is money.

Often money that is just sitting can later be moved into the right situation at the right time and make a fast fortune. Patience is the key to success, not speed. Time is a cunning speculator’s best friend if it is used wisely.

4) Let the position ride.

As long as the stock is behaving normally, do not be in a hurry to take a profit. You must know you are right in your basic judgment, or you would have no profit at all. If there is nothing basically negative, then let it ride. It may grow into a very large profit. As long as the action of the overall market and the stock do not give you cause to worry, have the courage of your convictions, and stay with it.
When I was in a profit on a trade, I was never nervous.

Of course the opposite is true as well. If I bought a stock and it went against me I would sell it immediately. You can’t stop and try to figure out why a stock is going in the wrong direction. The fact is that it is going in the wrong direction, and that is enough evidence for an experienced speculator to close the trade.
I do not and never have blindly bought and held a stock.

To buy and hold blindly on the basis that a stock is in great company or a strong industry, or that the economy is generally healthy, is, to me the equivalent of stock market suicide.

Stick with the winners. Let them ride until you have a clear reason to sell.

5) Take the profits in cash.

I recommend parking 50 percent of the profits from a successful trade, especially when the trade doubled the original capital. Set the money aside, put it in the bank, hold it in reserve, or lock it up in a safe-deposit box.

Like winning in the casino, it’s a good idea, now and then to take your winnings off the table and turn them into cash is the single largest regret I have ever had in my financial life was not paying enough attention to this rule.

More great information on Livermore can be found here.

Have an awesome day!

Collateral

Collateral is used to describe an object of high value that is used to guarantee the repayment of a loan. If repayments are late, or the agreement is defaulted, the collateral is taken in place of the repayment. Amongst the most common types of collateral are people’s houses in regards to their mortgage payments, or their cars if ‘part-ownership’ deals have been made. Therefore, mortgages are amongst the most common loans with collateral. For some of the top rates on mortgages, take a look at NatWest.

Secured and Unsecured Loans

A secured loan is one that has collateral back it up in the event of default, they usually have lower interest rates due to the fact that if payment isn’t made the lender has the ability to take ownership of the collateral and sell this to make up the money that they are still owed.

Accordingly unsecured loans are Loans that don’t have collateral. Instead they charge much higher interest rates so that if the repayment is unable to be made, the lender will already have received back much of his original capital and therefore make the smallest loss. Alliance and Leicester is provides some of the best rates on loans available from the reputable high street banks. Also, take a look at ASDA Finances for low rates on both secured loans and unsecured loans.

Equity

Equity refers to the monetary value of a property or business after the amount that is still owed on the loan originally used to purchase it is taken off. Most commonly that loan is the mortgage on someone’s house, which means the equity is the part of the house that is owned directly and solely by the individual and not the bank, or mortgage lenders. The more money that a person pays towards their mortgage then the more equity that they are considered to have.

Equity, therefore, is linked to collateral in as much as it is the equity that an individual holds on their house that is considered as the collateral in mortgage agreements.

Default

Defaulting is when an individual is unable to fulfill their obligations in regards to a financial agreement. Simply put, if you are unable to meet the payments of a mortgage, or of a loan, then this is considered defaulting. In regards to the current global credit crunch, the problems are simplistically assigned to large numbers of people defaulting on their mortgages in America. This was due to certain financial institutions taking the risk of agreeing mortgage terms with people who would not certainly be able to meet the terms of their mortgages.

These are just a few of the simplest terms that are found when addressing personal finance, particularly in regards to loans, credit cards, bank accounts, and mortgages. It is important to be closely familiar with them when dealing with anything financial, as slight misunderstandings can have incredibly grave consequences.

As we know, investing in dividend paying stocks is more complex than just searching for the highest yield. In fact, we know that high dividend stocks are often priced as such because there is a fundamental problem with the company and the extremely high yield is a signal of significant risk.

In the past we have learned to further investigate dividend yield with a number of factors.

Average Dividend Yield

First off, we like to compare a company’s current dividend yield to the average dividend yield offered by that company over time – 5-10 years is sufficient. The methodology here is to determine where the company is priced in terms of dividend yield based on where the market typically prices the company.

If the current yield is significantly higher than the average yield for that company over time, then it may be a buying opportunity. However, if the yield is extremely higher than the average, it may also be a signal of additional risk – something significant has changed and needs to be investigated.

Dividend Payout Ratio

Secondly, we must determine if the dividend payout ratio is within the normal range for the company. For example, if a company has an average dividend payout ratio of 40% and the current payout ratio is 80% then we must investigate the reasons for the change.

Most dividend paying companies companies have a policy that attempts to maintain a certain percentage of profits that will be paid out as dividends. If the dividend payout ratio moves significantly higher than the stated range, investors may be looking for a dividend cut!

With high dividend stocks, it isn’t uncommon to see dividend payout ratios greater than 100%. Obviously, it doesn’t take a genius to determine that paying out more in dividends than is earned in profits is unsustainable. This is why the examination of the current dividend payout ratio in relationship to the average for the company is a useful exercise.

Examples

To further illustrate the previous points about high dividend stocks and looking beyond the yield, let’s view a couple of examples.

Below is data gathered from Reuters on Proctor & Gamble and Yellow Media Inc.

As we can see, both Yellow Media and Proctor & Gamble offer dividend yields greater than their own 5-year average yields. Both give higher yields than the industry average, and both offer a better 5-year average yield than the S&P 500.

However, on one hand, we have Proctor and Gamble that is currently paying out 48% of profits in dividends, while Yellow Media is paying out, an unsustainable, 1o1.84%.

Perhaps even more importantly is how the payout ratio relates to the dividend growth rate.  If the payout ratio is high, that leaves little (or no) room for reinvestment in the business. If there is no reinvestment into the business, the potential for growth is limited.

As the data indicates, the dividend growth rate over the past five years for PG has averaged 11.81% , while Yellow Media’s dividend has remained essentially flat. If an investor has a long time horizon, the growth of the dividend may be more important than the initial yield.

Of course, there is more to evaluate than average yield and payout ratio when screening for dividend stocks,  but these are two excellent metrics to evaluate when screening for high dividend yields that are sustainable.

Companies with decent average dividend yields and reasonable payout ratios are thought of as reliable and safe investments that offer income as well as an opportunity for capital growth. The dividend growth model reflects how a company has performed in the past.

Since it is just an indicator of past performance, it will not guarantee how a company will do in the future. However, we can only use the information that we have to make an informed investment decision. So, in making an investment, the dividend growth model is a very useful tool for the construction of your portfolio of investments that seek to provide a growing income stream. However, it is not the be all and end all of due diligence that should be performed on a company.

To calculate how much a stock is worth based on the dividend growth model, you will need these three things:

1.)    Current dividend payout of the company

2.)    Growth rate of the dividend

3.)    Your required rate of return.

The current dividend payout and growth rate of a company can be researched online. I like to use Reuters as they display a lot of dividend information along with the other necessary financial information.

Your required rate of return is based on personal requirements for return on your investment capital.

How To Calculate Value Based On The Dividend Growth Model:

1. Add 1 to the dividend growth rate. For example, if the rate is 12%, add 1 to 0.12.
2. Multiply the sum with the current dividend payout. For example, if the payout is $1.50, multiply that by 1.12 to get 1.68.
3. Divide the product, 1.68, by your rate of return less the dividend growth. For example, if your rate if return is 20%, less dividend growth rate of 12% is 8%. Divide 1.68 by 8% or 0.08 and you get $21.

The above example values the stock at $21 based on a 12% dividend growth rate. Compare this value to the most recent closing price of the stock you’re considering. If the closing price is lower, then the model has indicated that this stock has met your criteria and is worthy of further consideration.   

The dividend growth model relies on variables that can change over time and, as such, can only calculate how the stock should be valued at the current dividend growth rate. As we have discovered from the most recent market downturn, dividends do not grow at a constant rate in perpetuity, so the value that we calculate using the dividend growth model can change!

Of course, as with any valuation model, there are risks associated with investing based on purely the dividend growth model. It does, however, provide a good data point for your investment analysis.

To know if the dividend growth rate growth can be sustained for many years, one can also evaluate the sales growth and profit margin trends. As market conditions change, it is useful to continue to run potential investments through the dividend growth model, accounting for changes in dividend growth rate and the dividend payout.

It is very important when investing to not only evaluate a company against others in its sector or industry, but also against itself.

In previous articles, we have discussed the dividend payout ratio, free cash flow, Z-Score and Return on Invested Capital (ROIC). All of these metrics are used as a way to evaluate stocks against their peer group, but also against themselves at different points in time.

When we have narrowed a company down against its peers, it is then time to evaluate the stock against itself at different points in time. Doing this can help us to determine if a stock is selling at a reasonable price.

How To Use Average Dividend Yield 

One of the greatest ways to evaluate a dividend stock against itself is to determine the average dividend yield that that stock has paid over the past number of years. If the stock has a higher than average yield, compared to its own historical average, then it may indicate that it is a better time to purchase shares (all other factors being equal).

There is an excellent tutorial on calculating average dividend yield at DividendsMatter.com. I will highlight some of the main points here, but I highly suggest that you read the full tutorial.

First of all, I like to gather 10 years worth of data for the stock. This is easy to do because the stocks that I analyze have very long histories of paying dividends. The information we need is the high and the low stock price, and the dividend paid out for each of the last 10 years.

This data can be gathered from many sources, including the company website.  However, I prefer to use Yahoo Finance because the dividend information can be filtered out from the stock price using this option.

This is all the historical information we need. Now, from this information, we can calculate the high yield and the low yield for each year. The high yield is calculated by taking the annual dividend and dividing by the low price. Similarly,the low yield is calculated by taking the annual dividend and dividing by the high price.

High Dividend Yield = Annual Dividend / Low Stock Price

Well Worth The Effort 

The mathematics of the process is very elementary, but it does take some time to gather the information.  This is certainly time well spent and I suggest that you practice on a couple of your favorite stocks. 

You will find that buying high quality, dividend growth stocks at prices above their average dividend yield will give you a margin of safety and confidence to hold the stock through thick and thin.

Obviously, this is one metric of many that will help guide you in your quest to buy quality dividend growth stocks. 

Please see: How To Choose Dividend Growth Stocks . for additional learning.