Along with Pin bar, absorption model is considered to be one of the most simple and effective PA patterns. It is not used as an independent trading strategy, but in combination with other tools it provides fairly accurate entry points to the market. In addition to the pattern formation logics, today we will also learn about the methods of its use in trading.
Like Pin Bar, this pattern combines particularly well with strategies based on horizontal levels. Absorption candles enhance beat off signal from support or resistance.
Let's take Horizon X TS as an example. Here plenty of entry points are based on chart beat off from support or resistance zones. Absorption can be used as an additional filter when concluding a deal. Another option is to increase a lot when absorption is forming at the moment when conditions for a deal are implemented.
Learn more about this TS using the link below.
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How the absorption model is formed
This pattern consists of two candles and somewhat resembles an outside bar model. The second candle is larger in size than the first and absorbs the first one. Don't confuse this model with rails; in absorption, body of the first candle must be located within the body of the second candle. At the same time, the first candle can be several times smaller compared to the second one.
During this model formation, change in forces balance is taking place. The fact that the absorption candle is bigger than the first candle of the pattern indicates that movement in previous direction is unlikely to continue.
Let's list the signs an ideal absorption is supposed to match to:
- different color of pattern's candles;
- big shadows presence is undesirable. The following rule is introduced - Close price for the second candle must be located in the lower or upper quarter of the range for bearish and bullish absorption, respectively;
- patterns formed during flat are not taken into work;
- if the second candle is much bigger than the first one and looks abnormally big against the rest ones, you are facing reaction to unexpected news. There's a high probability of a rollback, so it’s better to wait off entering the market.
Give priority to constructions that appear on previous timeframes. I.e. if you receive bearish pattern on H4, you should give up buying on M15-H1.
How to make deals using the absorption model
To take a pattern into work the following conditions should be observed:
- it was formed at the end of upward or downward movement;
- there’s a "prop" in the form of support or resistance level.
- Methods of making deals:
- at closing price of second candle of a pattern;
- by pending order placed behind High or Low of the pattern for bullish and bearish patterns, respectively. Pending orders usage is safer, but causes a bigger stop. But if the absorption model is close to an ideal, stops in both methods are comparable in size;
- by pending order, but at a rollback of 50% from the absorbing candle range. This method is recommended for use with big candles. If you enter them at closing price, stop will be less than TP and the risk is not justified;
- if the absorption model was formed before reaching the level, pending order can be placed based on future testing of those support or resistance. From the point of view of TP to SL ratio the method is not bad, but there is no guarantee that the chart will test the level.
There is no the best method out of the 4 listed above, so just be guided by the situation. If the pattern is strong, "supported" by a level and SL is less than the TP, use the 1-st or the 2-nd way to enter the market.
In the examples above, stop was set up out of the extremum of the pattern, but instead, SL can be set up according to ATR. Use the Stop Loss formula = 2 x ATR.
Indicator for searching the absorption model
- sets up stops and TP in several ways. Standard ATR is used;
- has filter of false breakthrough of a signal candle extremum;
- has shadows' size filter of absorption candle;
- marks the patterns that worked out and ones with no profit achieved.
For each pattern:
- its formation area is indicated;
- the arrow points at the candle where the indicator considers the pattern to be finally formed;
- pending order setting level is displayed. The indicator assumes working with pending orders placing them behind the absorption candle;
- shows the take profit setting up levels. Partial profit fixation is assumed. Tactics resembles Safe rule of Horizon X TS; this approach allows to get to breakeven rather quickly.
Information on the location of TP and SL levels is duplicated in the information window in the upper right corner.
The indicator marks all absorption models that meet the criteria with no exception. Market condition is not evaluated.
Significant part of patterns that didn't work out can be excluded by manually filtering market's condition. For example, not to take into work bullish absorptions in a growing market with a downward correction of 1-2 candles. The same is relevant for absorption candles with long shadows.
Absorption is one of the most common Price Action patterns. It doesn’t have 100% working out, but combined with levels and trend lines it works quite well. Don't take these patterns into work provided no amplifying signals have been received.
The same applies to indicators facilitating the patterns' search. Manual filtering of absorption patterns is needed.
The best option is using a strategy based on graphic analysis and adding absorption as a signal that strengthens the entry point. As an example of such a strategy check out Horizon X; learn more about it using the link below.
Get free basic Horizon course here