Supply and demand trading is one of the most popular as well as useful ways to trade financial markets. In fact, the dynamics between supply and demand have been right at the heart of almost all trading strategies.
Do you also want to know about the holy grail in trading? Then you are at the right platform at the right time. In this article, we are going to explore different aspects of supply and demand trading. Let’s jump into what this concept is and how you can capitalize on it to transform your trading.
The basics of supply and demand trading
Before understanding supply and demand trading, it is important to understand supply and demand as a concept. It is a very important concept and a law in economics. The law states that prices of products must fall to incite consumers’ interest when the supply of those products is high while demand is low. Conversely, prices of products must rise to indicate a scarcity of products when the supply of those products is low but demand is high.
Supply and demand is a very simple concept. However, no one can underestimate the importance of what this law brings to the floor. In simple words, this law of economics actually plays a defining role in determining the prices of products or services.
Supply and demand law may sound familiar to you. If not, it is our responsibility to make the concept clear to you. That’s why we are going to explain it using an example.
Suppose that you want to own a home. So, what are the major factors that define the price you are going to pay? Of course, there are numerous factors but at the heart are supply and demand. Let’s say the population of your country is high and the birth rate is also high. Thus, a higher population means the high demand for new homes is high. What is the reason here? The reason is that a high population leads to high demand for new homes and that pushes prices high.
On the flip side, let’s also suppose that the population of your country is not so high and the birth rate is also low. That means the demand for new homes is low and therefore, prices are also low. Why so? Because demand is low and prices must decline to incite interest from home buyers. Does that make sense? Great!
Similarly, supply and demand determine the prices of all types of products or services. But what about trading? And what about prices of stocks, forex, cryptocurrencies, commodities, etc. ? Does the same law apply to the financial markets as well? The answer is yes.
The law of supply and demand in financial markets
Again, it is pretty simple to understand how supply and demand affect the prices of financial instruments. The same rules also apply to financial markets. Let’s see how.
There are different factors such as economic conditions, new events, etc. that make traders buy or sell financial instruments. This buying and selling affect the supply and demand equation. Thus, supply and demand eventually determine the prices of financial instruments. Furthermore, it is amazing how price charts visualize supply and demand.
- When an uptrend begins to form, it means demand is outstripping supply
- Conversely, when a downtrend begins to form, it means supply is outstripping demand
- And when prices move sideways, it means supply and demand are balanced
Simply put, supply and demand in financial markets cause a “play by play commentary” that continues day by day, weekly, monthly, yearly, hourly, up to 1-minute basis. That’s why you see the formation of price patterns on charts.
Supply and demand trading – the formation of supply and demand zones
So, we hope you have a sound grip by now on supply and demand as an economic concept. With all that in mind, a couple of questions arise here;
- How does it all link up and form supply and demand zones?
- How does it help to predict when and where could market reversal begin?
Again, it is supply and demand trading that gives you answers to such questions. Moreover, this is the point where it all gets interesting. So, never miss a point.
The role of Big fish in financial markets
Firstly, it is important to know one simple fact. Big fish play a decisive role in pushing prices higher or lower. It is true because supply and demand are considerably affected only when big players in the market begin to buy or sell. As you know, we don’t have enough money and buying/selling power to influence prices. Contrarily, big investors with loads of money in their accounts affect prices with their unlimited buying/selling power.
Secondly, the previous point leads us to another point. And that is how do big fish do this without getting noticed? In other words, how do they enable themselves to enter the market at the best possible price level?
The answer is – banks, other financial organizations, and other big investors don’t place their entire orders at once. Placing their full position all at once means pushing prices out of their reach. Therefore, they divide their entire position into small multiple orders. So, they place each order at an almost similar price level. And thousands of other traders like us help big fish achieve this. How? Let’s see how!
As you know, big players also need their counterparts to do the opposite to enter trades. For example, they need buyers to buy when selling and they need sellers when buying. That’s why they invest in multiple small orders. They place one trade and let prices rise by increasing demand. However, they also cause prices to fall back from a certain level to get another position. Thus, big players make prices move between supply zones and demand zones by affecting supply and demand.
Finally, it is up to us to help ourselves make money. Yes, you read it right. We need to identify those supply and demand zones to make money. It enables us to enter and exit markets at the best possible price levels. This is supply and demand trading.
Supply and demand zones
As you know, there are two types of zones – supply zone and demand zone
The demand zone is the area on your price charts that indicates high demand. It is the high demand that forms key areas on charts known as support areas. Now, how do such demand zones form? You know the answer. Yes, big players cause the formation of demand or support zones when they begin to invest huge sums of money. And these are the areas where you see reversals of the strong bearish trends in the financial markets.
The opposite of the demand zone is the supply zone. It is the area on your price charts that indicates high supply. It is the high supply that forms key areas on your charts known as resistance areas. Again, how do such supply zones form? You know the answer again. Right, big players cause the formation of supply or resistance zones when they begin to sell huge positions. And these are the areas where you see reversals of the strong bullish trends in the financial markets.
Supply and demand trading strategies
The rule is simple here – you should enter or exit trades on supply and demand zones when using supply and demand trading strategies. These are the reversal zones that offer the perfect price levels to enter or exit your trades. In other words, the perfect way to optimize your trading is vital to correctly identify those areas.
How to identify supply and demand zones?
Correctly identifying supply and demand zones is the key to supply and demand trading. Typically, sharp price rises or declines are tell-tale signs of these zones. Therefore, you need to determine those sudden rises or declines in prices on your charts. It is also important to remember the fact these sudden price jumps indicate banks and other large institutions are opening or closing their positions. Thus, making prices take huge jumps.
So, how will you correctly identify supply zones or demand zones? You will identify those zones by looking for sudden declines or rises in prices. For example, you can identify a supply zone by locating sudden declines. That means large financial institutions are selling their positions. Thus making supply outweigh demand and that eventually makes prices fall dramatically.
Similarly, you can identify a demand zone by locating a sudden rise in prices. That means large financial institutions are buying on a large scale. Thus making demand outweigh supply and that eventually makes prices rise dramatically.
Furthermore, sharp rises or declines are the indicators that are easiest to locate. However, it doesn’t necessarily mean that only sharp rises or declines indicate supply or demand zones. Prices may move sideways while being at the supply or demand zones for a while. It happens because large institutions need prices to move back to these zones to enter or exit their entire positions.
Supply and demand trading
We have made it pretty easy for you to identify crucial supply or demand zones. Now, it is time to move ahead. Yes, it is time to discuss supply and demand trading. So, how can you trade supply or demand zones to maximize your trading performance?
New trading strategies are being developed with each passing day. And new ways of trading existing strategies are also being developed. Therefore, trading has become comparatively easy but more fruitful for traders. However, it doesn’t mean that you start to underestimate the risks and uncertainties presented by the trading world.
That said, supply and demand trading strategies have also evolved over the years. There are multiple strategies to trade supply or demand zones. However, we are going to discuss the most popular and effective strategies.
1. Price action entry
Price action entry is one of the widely used supplies and demand trading strategies. As the name suggests, this strategy involves using price action to trade zones. Candlestick patterns are keys to the successful execution of this strategy as you use candlestick patterns to enter or exit. The steps to execute this strategy are;
1. Firstly, you need to correctly identify the supply or demand zones.
2. Secondly, you need to wait for the price to touch or enter the edge of the zone. You also need to confirm the reversal before entering.
3. Thirdly, wait for a reversal candlestick pattern to form. That provides evidence for trend reversal. The most important and reliable reversal patterns are bullish and bearish engulfing patterns. Therefore, wait for an engulfing pattern to form and then enter.
4. Finally, set the stop-loss according to your own risk management techniques. However, the most effective level to set stop-loss is just outside the zone.
2. Set and forget the entry
The second reliable strategy for supply and demand trading is set and forget entry. Sam Seiden proposed this technique and it is quite popular as well. This strategy involves using limit orders to enter a trade. The strategy suggests placing limit order at the edge of the zone. When the reversal happens, it executes your limit order and gets you on the way.
Once your order gets triggered, you can place stop-loss just outside the zone. However, it is important not to place stop-loss close to the edge.
The main advantage of set and forget entry is that you never miss a reversal. On the flip side, the major drawback of this strategy is price may breach the zone and make you incur huge losses.
Supply and demand trading tips
Supply and demand trading can help you maximize your trading gains while minimizing risks. Therefore, we also decided to give you some tips to maximize your performance.
- Learn all about areas of support and resistance as supply and demand zones lead to the creation of these key areas. It is important because key S & R areas are perfect for decision-making.
- Always remember that supply and demand zones may spread across a wider area than S & R areas.
- Analyze price action for supply and demand trading using both S & R areas as well as supply and demand zones.
- Correctly identify whether you are in a demand zone or a supply zone. Prices are always lower than the bid prices when in a demand zone. Conversely, prices are always higher than the bid prices when in a supply zone. Whereas, bid price refers to the price of a financial instrument a trader is willing to pay.
- Learn candlestick patterns to correctly identify reversal patterns. For example, engulfing patterns are reliable reversal patterns. You need to learn about such patterns. Only correct identification of reversal patterns enables you to enter or exit a trade at the best possible price.
- Finally, it is also crucial to understand rally or drop patterns. Sudden and sharp price declines or rises are good indicators of supply and demand zones. With that in mind, it is imperative to know all about the rally and drop patterns. Additionally, you can also buy low and sell high when you know about those patterns. For example, a rally pattern helps you buy low and sell high as you can anticipate an upcoming rally when you understand rally patterns.
The best supply and demand trading books for better understanding
Supply and demand trading can be instrumental in your trading success. Therefore, it is vital to enhance your knowledge about the concept. And the best way to enhance your knowledge is through books. The following books can also help you enhance your supply and demand trading knowledge.
1. Supply and Demand Trading by Derby Matoma
Supply and Demand Trading by Derby Matoma is a comprehensive book for beginners. The author explains in detail how supply and demand zones are formed. He also explains how they are formed and goes on to discuss how to identify them. Do you want to trade along with big fish like banks? Then this book is the best bet for you.
2. Introduction to Basic Supply and Demand Trading for Beginners by Joe Okane
Introduction to Basic Supply and Demand Trading for Beginners by Joe Okane is also among the top books. This book is so good that it significantly cuts down beginners’ learning curve and prepares them for practical trading. The author makes supply and demand trading really easy and simple for you even if you have zero knowledge about the concept. So get the book and enhance your knowledge.
3. Supply and Demand Trading 101 for Beginners by J.R. Calcaterra
Another worthwhile book on the supply and demand concept is Supply and Demand Trading 101 for Beginners by J.R. Calcaterra. The author wrote this book, especially for beginners. Therefore, if you want to be a self-directed analyst and trader, this book can help you beyond your imagination.
4. Trade Like Pro by Jode Lebin
Trade Like Pro by Jode Lebin is also a revolutionary book on the topic at hand. The book explains how to trade forex as well as other markets using supply and demand zones. You will learn through a step-by-step guide and practical approach. So, get the book and learn all you need to know about supply and demand trading.
5. Market Stalkers by Deeyana Angelo
Market Stalkers by Deeyana Angelo is also a great option for learning different aspects of supply and demand. The book leads you to correctly analyze price action patterns. You will also learn about how to find high probability locations of supply or demand zones. That said, if you want to systematically trade, this book is for you.