Traders normally have two main end goals: capital appreciation and cash flow. Capital appreciation trading is geared toward compounding gains over the long haul in order to increase wealth. The intent of cash flow trading is to attempt to capture numerous small moves within larger trends—what I call “milk money” trading.
If you’re going to attempt to trade for cash flow, that generally means you’re trying to grab incremental profits in short time frames. For this type of trade, I use Prophet charts within the thinkorswim® trading platform from TD Ameritrade. I star with a 20-period exponential moving average (EMA), denoted by the green line on Figure 1. Next I add a moving average envelope (MAE) set to a period of 20 and a percent shift of 4%. These are the purple lines above and below the price action. Below the chart, I have the Awesome Oscillator (AO) set to 5 and 21. And finally I have an average true range (ATR) set to 14. Let’s take a look at the setup.
Milking the Trade
This trade revolves around the idea of prices reverting to the mean. We aren’t looking to trip all over ourselves chasing momentum. We aren’t trying to guess how high prices will go or how low they’ll fall. We are just looking for the price action to revert back to the mean, which, in this case, is the green 20-period EMA.
My signal is twofold: First I wait for price action to test the upper or lower purple MAEs. Once that happens, I wait for the AO to change colors. When it does, I take the trade.
At point number 1 (Figure 1) we get a test of the upper MAE. But hold on: patience is a virtue here. Remember, we need to wait for the AO to change colors, which it does at point 2. I buy at point 3 and hold on until point 4, where my target is hit.
We get another test of the upper MAE at point 5. I wait for the momentum to change, which it does at point 6, and my entry is at point 7. Once again, I take the trade, and in this case, the target is hit the next day. As you can see on this chart, the same scenario is repeated at points 8, 9, and 10.
Word of Caution
Remember, this trade is an attempt to time the market action for small gains—in an effort to pay for your Starbucks habit. The downside is that if the markets run away to the upside or downside, there isn’t much to do but wait, and you can miss out on a lot of the price moves. And things don’t always work out as planned. Just because the intent is to generate cash flow doesn’t mean that it will happen.
You could just as easily lose more milk money than you make, so always remember to trade only with money you can afford to lose.