Absorption when properly understood and executed on is an approach that uses specific criteria to that gives a great trade setup. You may hear the term “trapped traders” and while this name is fun and catchy I don’t really subscribe to the idea... Lets' do a run down.

Something I have long referred to as liquidity zones... When we move away from these area’s it is not a result of trapped traders but traders get “trapped” as a byproduct of running into areas of high liquidity.

Perhaps its semantics but when watching the DOM you can see these area’s being traded and the more time you spend watching and understanding what’s happening, it will become more apparent to you that it’s the passive party that is dropping liquidity in zones like a firehose.

Before we continue, lets backtrack a little bit because you need to understand a few things before we dig into the weeds. On the orderbook, the DOM, the Depth of Market or the ladder you will be able to see the limit orders that are considered “resting”.

These “resting” orders change all the time, but if we take a snapshot in time this is what the orderbook looks like for NQ on any given day.

In the example above in order for a transaction to happen, someone else has to enter the party with a marketable order which could be sell bid or sell market and in this example they would sell 22003.50.

When this transaction happens you would see sell on the time and sales and the quantity and for argument purposes lets assume the trader here sold 3 at market, assuming nothing changes on the orderbook after that transaction the next best bid would be 22003.00 with a bid quantity of 4 showing and the last traded price would be 22003.25. This is a very simplistic way to describe what happens in micro seconds/milliseconds as orders are conducted across the orderbook day in day out. However it’s essential to understand that generally speaking for a market to move you need both passive (limit orders) and aggressors (market orders).

Now that you understand this dynamic between the limit order book and how trades are conducted you can get a better grasp on this idea of absorption and how to use it practically.

So as I mentioned above, in liquid markets like ES and NQ (as well as other futures instruments) there are transactions happening all of the time in microseconds, picoseconds and I’m sure faster than that and it’s not necessary for you to watch every tick or transaction if using the DOM to watch OrderFlow but you can use it as one of the tools along with another tool called a delta profile or a footprint, more on those later.

Ok, so we know that we have transactions occurring all the time and the majority of this activity is pretty much noise and its important to note that. However, there are times where you will want to pay more attention to what’s happening in real-time.

Scenario: You’re watching the DOM and seeing buyers aggressively moving the market higher, by lifting offers (market orders) and also refilling limit bids, this is activity we see when we say the market is “bid”.

At some time we notice some slow down in price movement and start looking at the DOM and in this area we start seeing some offer reloading as well as an accumulation of delta on the delta profile or footprint.

This is a clue to “tune in” and watch a little closer. What you’ll likely notice is a few things. Larger than normal limit orders being placed on the book. Limit order refreshing (hidden liquidity) Accumulation of delta on the delta profile or footprint

Large amount of limit orders on the offer.

Accumulation of Delta on the delta profile or footprint.

Reloading of limit orders *large and small* Did you catch the offer reload at 22020 at the end?

This activity combined with price going sideways is textbook absorption in my playbook and the key to identifying it correctly is the last element. In order for the high liquidity to “hold”.

Price needs to be going sideways as a general rule, and while it never really “barcodes” exactly sideways you hopefully get the drift. Absorption takes time.

So then we can say our formula for absorption is something like this: Large limit orders taking fills + Refilling activity + Delta accumulation + Sideways price = Absorption

Do all of the above NEED to be seen for absorption? No. you can certainly “miss” refilling on the order book or maybe larger orders won’t even be present, but these are the general activities you should be looking for.

Be careful to assign absorption to things that are not absorption, such as simply seeing large deltas. Just because you see large deltas on the profile doesn’t mean you have absorption, if price continues marching higher/lower, its not absorption.

Big Deltas alone does not equal absorption.

Just because price is going sideways, does not mean absorption either, price can pause/consolidate for as long as it wants before resuming in its original direction.

As far as practical application goes it seems like I will need a part two. Until next time 👍

Do You Trade Stocks & Options? I received my license for trading Stocks & Options in '05. Each day, I share options trading watchlists, market insight and professional trading strategies. ZERO cost, zero strings attached. Follow along & learn to trade strategically.