The Orderflows Absorption Course

Module 3 – Recognizing Absorption

 Disclaimer
This presentation is for educational and informational purposes only and should not be considered a
solicitation to buy or sell a futures contract or make any other type of investment decision. Futures
trading contains substantial risk and is not for every investor. An investor could potentially lose all or
more than the initial investment. Risk capital is money that can be lost without jeopardizing ones
financial security or life style. Only risk capital should be used for trading and only those with sufficient
risk capital should consider trading. Past performance is not necessarily indicative of future results.

CFTC Rules 4.41 - Hypothetical or Simulated performance results have certain limitations, unlike an
actual performance record, simulated results do not represent actual trading. Also, since the trades have
not been executed, the results may have under-or-over compensated for the impact, if any, of certain
market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the
fact that they are designed with the benefit of hindsight. No representation is being made that any
account will or is likely to achieve profit or losses similar to those shown.
Absorption is measured by analyzing passive trading activity. Most traders
only look at aggressive trading activity which is what moves the price up and
down.

Absorption can be seen in sideways activity.

One of the drawbacks in analyzing passive activity is you don’t know if it is

profit taking or a new position. However, a trader in a position taking profit is
more inclined to move his passive order to an aggressive order if the market
starts ticking away from him. After a big move up the first signs of aggressive
selling is most likely due to profit taking than supply hitting the market.
Sideways absorption – heavy volume
Don’t confuse with consolidation – light volume.
Understanding when a market is experiencing absorption is important
because is you are in a trade and a market starts trading sideways it can be a
sign of either absorption or accumulation (distribution).

If it is absorption the market will most likely reverse.

If it is accumulation (distribution) the market can resume its move in its

original direction.
Strong up trends do not break easily.

As a market keeps moving up it attracts additional buyers until the market

reaches a point where it is trading too far above value where traders start to
notice how far away from value the market is currently trading where they
start selling. (Can see price exhaustion).

On this price action, traders late to the party start getting long (usually trend
traders) and push prices up where the sellers are happy to sell more supply.
Eventually the buyers dry up and the move down starts gains momentum to
the downside. This is where you want to get short.
Strong uptrend
When it did break
Absorption can also tell you when momentum has stopped.

A market that has been selling off, taking out lows, all the shorts are happily
counting their money. But the market hits a level where there are passive
buyers waiting for the market to come to that level.

Almost like a sleeper cell, the buyers awaken and start buying more, not
wanting to miss the buying opportunity at the low prices. The aggressive
buyers are coming in, buying imbalances are appearing, delta is getting
stronger. But after a few bars, price isn’t really moving higher, delta is
contracting, no imbalances for a while.

What has happening? Momentum has stopped. It may be absorption, it may

not.
Buyers coming in
Sellers coming in
Sellers coming in – might be easier to see on
Delta chart
What is happening at the high is aggressive buyers are coming into the
market and lifting the offers. As the market is rallying, price is going higher,
sellers are attracted to the higher prices and start offering their supply on the
offer side on the way up in the order book.

Aggressive buyers are buying those offers from the passive sellers which is
reflected in the strong positive delta.

Finally the buyers are exhausted because of excess supply. Then sellers
sense that prices are very high and a good selling opportunity. The sellers
don’t want to miss out, so while keeping their offers in the order book, they
begin hitting bids at and around the highs of day. This is reflected in the
negative delta and sometime small positive delta.
Chart
What happens when the market sells off is the sellers get triggered, heavy
selling volume comes into the market, traders are tripping over themselves
hitting the bids reflected in a strong negative delta number. Overall volume
for the bar is above average. Then buyers appear at the low prices. Demand
has come to the market. Traders see the low prices and want to buy, they start
aggressively lifting the offers which is reflected in positive delta.

Depending on how much selling pressure remains the market can go

sideways before rallying. If sellers, reload the market can continue lower after
the breather of sideways activity.
Sellers tripping over themselves
More obvious on delta footprint
Absorption doesn’t usually occur at one price level the way bar point of
control shows. It can, but usually it is spread out over several price levels.

One of the easy ways to determine this is watching the delta. The delta will
increase either positively or negatively but price won’t move with it.
Chart
Chart
When looking at absorption, you have to look at it occurring over a period of
time. I think it is difficult to see absorption occurring on a very short time
frame, like 1-minute or 3 range charts. On short time frames you can see
transactional moves by funds, whereas on longer time frames you can see the
strategic decisions. When looking at 1-minute charts, one or two big orders
during a 60 second period can skew the data you are analyzing.
This concludes module 3. In module 4, I will discuss accumulation and
distribution and how it relates to absorption.

See you on the next module.