Understanding Absorbing Candle Theory: Spotting "Smart Money" Accumulation and Distribution

 

Absorbing Candle Theory: Spotting "Smart Money" Accumulation and Distribution :

Absorbing candle theory refers to a volume-based trading concept that identifies when institutional or large players "absorb" the selling or buying pressure from retail traders at specific price levels. This creates distinctive patterns on candlestick charts that can signal potential reversals or continuation patterns.

Key Concepts:

1. What is Absorption? Absorption occurs when there's disproportionally high trading volume near a candle's high or low, but with minimal price movement beyond that level. This suggests that large institutional players are using limit orders to absorb the aggressive market orders from smaller traders ATAS.

2. Two Types of Absorption:

• Supply Absorption: Occurs when aggressive market sells encounter passive limit buys from institutions, who absorb the supply
• Demand Absorption: Happens when aggressive market buys meet passive limit sells from institutions, who absorb the demand

3. Visual Characteristics:

Supply Absorbing Candles often exhibit:

• A "b" shape pattern (wider at the bottom)
• High volume concentrated in the lower portion of the candle
• Large lower shadows/wicks
• Dark red coloring in footprint charts indicating aggressive selling

Demand Absorbing Candles typically show:

• A "p" shape pattern (wider at the top)
• High volume in the upper portion of the trading range
• Significant upper shadows/wicks
• Volume accumulation near resistance levels

Trading Applications:

Entry Signals:

• Look for absorption patterns at key support/resistance levels
• Confirm with volume indicators and footprint analysis
• Wait for price reaction after absorption occurs

Market Psychology: The theory suggests that institutional players position themselves at strategic levels to:

• Accumulate positions at favorable prices
• Defend important price levels they want to protect
• Create liquidity for their large orders

Confirmation Factors:

• The pattern is most effective at established support/resistance zones
• Higher than normal volume is essential
• Price should show difficulty moving beyond the absorption level
• Follow-up price action should confirm the reversal or continuation

Limitations:

• Requires advanced charting tools with volume analysis capabilities
• Works best with liquid markets and sufficient volume data
• Not all high-volume candles represent institutional absorption
• Must be combined with other technical analysis methods for best results

This concept is particularly popular among traders who focus on order flow analysis and institutional activity tracking, as it helps identify where "smart money" is positioning itself in the market.