Absorption is the process of excess selling or buying taking place at a single price or series of prices but being absorbed by resting orders.
Absorption happens when the limit side of the order book is recharged or reloaded by new volume until all aggressor volume is taken.
Absorption is first and foremost the result of willing buyers or willing sellers at key levels. They absorb excess supply or demand and often times create a stopping point and cause the market to test in the other direction. Bookmap™ visual chart makes this easy to witness and take action upon. Absorption orders are very often present at key levels and confirm the importance of it by adding liquidity in the form of resting orders. Passive buyers or passive sellers often are large traders or institutions that place large orders at prices they want to defend. They "sit" on those prices and absorb supply or demand from the aggressive traders.
IF the aggressive buyer or seller is unable to "take out" the level where absorption is occurring then the market will often bounce away from the area of absorption as the aggressors are quick to cover their positions.
Buying Absorption - This is where large resting sell limit orders (sometimes in the form of iceberg orders) absorb excess buying.
Selling Absorption - This is where large resting buy limit orders (sometimes in the form of iceberg orders) absorb excess selling.
Absorption happens every single day in all markets but some are more important than others. Some occur at intraday swing levels and while others are often present at key tops and bottoms on longer time frames.
Educational Video about Asorption
Chart Set Up
Here a quick set up video guide.
Now you will have the same set up as every available order book like Jigsaw Daytradr or other similar order book software.
Top vs. Bottom
As you can see in video above a traditional buying climax at the end of an up move will often see huge volume but with an inability for the market to push higher. It can also be seen as narrow range bar or bars on a traditional chart.
Interestingly enough, market bottoms usually exhibit slightly different characteristics. We should differentiate between Absorption and Rejection. Rejection means that the price drops down suddenly with climatic volume. Immediately after the price drop price reverses as fast as it went down. This is the result of passive buyers who are providing liquidity to soak up all the supply from aggressive sellers.
The key thing to notice when this pattern occurs is whether it manages to stop price or not. If it does, look for a good bounce.
If the level that had the absorption does not hold, then obviously price will carry on down. As you might expect, this prior support will now become resistance and often price will return to this area later to check it out since it experienced active interest by BOTH buyers and sellers.
Often the bears will now defend this territory that they have just won and it is often evidenced by fairly high volume traded at the ask.
This represents passive sellers selling at previous support to the willing aggressive buyers.
Euphoric and Pessimistic Market
Please note that absorption must be considered differently between an upward and downward trend.
When the market is bullish or euphoric the above described characteristics are true. Everything is massively "eaten" by the offers to finish this euphoric move. In other words: The generated energy at the top must be brought to a stop with counter-energy.
When the market is bearish or pessimistic fear rules the way down and it takes more time to turn the move into a positive terrain. Reloading on the bid side is hesistant and is more harder to assess as it is at the highs of a move.
How to trade
First of all you need a classical order book in front of you and a good understanding of an auction and the mechanics behind it.
Secondly it is hard to spot on very thin markets like NQ, YM, FDAX, 6E, CL and others. BUT it is excellent spotable on markets like Treasuries, ES and other markets which has enough liquidity to give us the time to see what is evolving in the order book.
Data visualization tools like Bookmap™ supports the trader to see the liquidity in the order book and concentrate on the moment of the event in the order book and watch how market agents behave in order to maniplulate the market in a direction.
I would recommend to trade absorption when the euphoria is overwhelming as documented in the video above.
Trading absorption in a down move is much harder to see and to trade. Therefore I don't want to give examples or recommendations because it depends on the trading experience of the individual trader how to trade.
I would be happy to see your ideas and comments about absorption in the comments below.