Breaking Down Supply And Demand Zones – What You Should Know When Trading Them

Understanding the market structure is essential for any trader to make meaningful gains in the trading scene. As such, you need to be able to tell when the price is right and when it is not favorable for you to either buy or sell into the market.

Now supply and demand are significant forces that determine the price of just about any commodity or asset across the globe. On a trading chart, the supply and demand zones tell a great deal about the prevailing market conditions.

Traders regularly rely on these areas to determine when to buy into the market and whether to abstain. The concept of supply and demand is tied to several other facets surrounding the trading scene such as support and resistance points and even trends.

So if you want to become proficient when it comes to interpreting these supply and demand zones, you have come to the right place. This article will outline the essence of supply and demand in the global markets, show you how to identify the zones, and further give you a couple of tips to trade along the supply and demand zones successfully.

Supply And Demand In Trading

Supply and demand are the chief driving force behind asset price and pretty much the cost of any commodity across the globe. Supply points to the availability of a particular asset in the market whereas demand indicates the interest generated towards that asset.

Market players drive both supply and demand. In the former, selling assets contributes to the supply of the same whereas buying drives up demand.

Supply and demand are at the center of any trading scenario and often determine the prices in the prevailing market. As a rule of thumb, high asset prices are derived from increasing demand. Sellers will typically cash in on the interest generated towards their product.

The Laws of Supply and Demand

In a broad sense, any market you can think of adheres to the laws of supply and demand. This way, market prices are usually determined by the interest generated in them as well as the available quantity.

Law of Supply

Higher prices usually point to increased supply. Traders are out to make a profit and often will dictate the highest possible price they can get from their commodities.

Law of Demand

Decreasing prices often drive demand. Since buyers are looking for the best bang for their buck, a dip in the cost of an asset means that the interest in the said item will go up as buyers see a good deal in buying into the market. Traders usually buy when the price is low and speculate for upsurges in price.

On the flip side, when a product is readily available on the market, it points to a massive number of sellers delivering to the market. As such, because of the variety of sellers, asset prices dive.

In the trading scene, steady supply and demand forces impact the price trend. When prices are rising, the demand for a trading instrument is also on the rise. Similarly, the prevailing rates exhibit a strong uptrend due to the general interest buyers have in an asset.

In general, when buyers are more than the sellers, demand is generally high. However, over time, the number of sellers entering the market goes up as they attempt to satisfy the buy orders. With increasing supply, the price curve slows down due to falling prices.

Many sellers introduce several options, and the prevailing price takes a hit. In the end, a bearish trend is exhibited on the price curve as the number of sellers goes higher than buyers. The only way the price will recover from this bearish trend is if the buyers outnumber the sellers and generate interest in the asset once more.

From the principles of supply and demand, we can determine when there are many sellers in the market. This further assists us in pointing out the region where supply is heightened and subsequently, the supply zone. Also, where buyers outnumber sellers, demand is generally on the higher side and hence a demand zone forms.

What Are Supply And Demand Zones

Supply and demand zones

Supply and demand zones lie where the forces of supply and demand are most significant. On a price curve, these points usually are at the extremes.

Supply and demand zones are quite similar to support and resistance points. The former only has a much broader reach as compared to either support and resistance. Other traders can equate supply and demand zones to much more extensive support and resistance areas.

Whatever the definition given for supply and demand zones, you can always find them bordering support and resistance. These two regions often have a higher concentration of buyers and sellers, hence driving both demand and supply up, respectively.

On a trading chart, supply and demand zones can easily be located more so if you consider historical data. Even so, one has to understand how the price line moves to pinpoint precisely where supply and demand zones will fall.

There are two distinct points on the price line that denote both supply and demand:

Accumulation phase

At this point, the price is at its lowest, and institutional traders are buying into the market. The smart buyers then drive the price up once they have accumulated enough assets at a favorable rate.

Distribution phase

Usually follows accumulation. At this point, traders normally offload their position at a higher price. Following their successful rally that allowed the asset prices to climb, traders capitalize on those traders who weren’t able to gain entry into the market earlier on. A higher price means good profit for these traders.

Identifying supply and demand zones on a trading chart

The price chart holds all the information traders need to trade. Supply and demand zones can then be identified on a trading chart once you know how the price moves.

  1. You can pin-point supply zones by looking for sharp drops between two individual candles or consolidations in the price candles. The joined candles are known as a base and often display a very tight range.
  2. In the case of demand zones, watch for large movements upwards from the consolidated candles, or even a solitary candle.

These zones comprise are joined by any two candles or groups of the same. Zones that arise from consolidated candles hold far better prospects when trading. This is because the price held out for a while as traders jumped into the bandwagon.

As such, on the onset of trading, traders offload their assets into the market. This, coupled with additional trading forces from outside the market, increases liquidity and eventually, the market shifts from this zone.

Determining the strength of supply and demand

If you want to trade at the supply and demand zones, you need to gauge the strength of these points. Supply and demand are forces that are always at play in various global markets. As such, there usually is a balance that allows gradual price changes and predictable moves.

On the flip side, however, drastic moves out of supply and demand zones tip the balance scales to either side.

Additionally, the timeframe in which the price was held at either zone may be used to conclude its strength. When the timeline is short, it means traders are not waiting for anything. Institutional traders are, at this point, aggressively driving the demand forces. Such individualistic traders cause the zones to spend the least amount of time at one end and move away quickly.

Price moving far away from either zone means that upon its return, the potential reward from trading at this point will be high. Likewise, an elastic band once stretched sufficiently will return with an even greater force. Therefore, the further you pull away from a zone, the higher its strength once it returns to the said zone.

Trading supply and demand zones

Supply And Demand Zones

Supply and demand are two principles that significantly affect the trading scene. In a nutshell, the price of commodities is at the mercy of the forces that drive demand and supply. So as a trader, if you want to know where the money lies, watch out for these forces.

Trading supply and demand, with hindsight, can be rewarding.  Here are some guidelines that will help you capitalize on supply and demand zones.

·         Watch out for volatility

Volatility affects the stability of prices in the market. Such a market typically indicates fluctuating prices and an unpredictable market scene.

Fewer or small fluctuations in price typically characterize a supply zone. As such, the following breakout will be robust further increasing your chances of profit. This applies to both supply and demand zones.

·         Timing is everything

One of the factors that determine the strength of any zone, either supply or demand, is the amount of time the price line spent at these points.

Accumulation of assets is a key highlight of the demand zone. This usually takes time but during extended stints, the likelihood that smart money traders are pushing the demand is unlikely.

Ideally, you should be on the lookout for shorter zones of accumulation. These would assist you during re-entry into the market as pull-backs are in high gear.

A short timeframe means that institutional traders are behind the trade, and as a sole trader, following the smart money is an excellent choice to make. A good supply zone is not stretched and demand doesn’t hold out for long.

·         The spring pattern

Following the big players in the market is, without a doubt, rewarding. One of the ways you can do this is by following the Spring Pattern. Defined by Richard Wyckoff, a respected stock market authority, the spring pattern refers to price movement in a direction opposite the subsequent breakout.

At a glance, the spring is a false breakout but watch out for this pattern. Traders are led to trade in this false accumulation zone as smart money traders collect buy orders before pushing demand high and consequently increasing the prices along the way.

·         Strength of reversal points

When the price turns, there usually is an imbalance created between buyers and sellers. The price movement usually takes a hit. However, whichever side you lie on this point offers good trading prospects.

Once the price switches from a bearish trend to a bullish one, there usually is a firm conviction among traders who aggressively take in all the orders further driving the price upward. The opposite holds when a bearish trend emerges from a bullish one.

·         Freshness

Always trade the zones that have not seen the price revisit the area in a while. In any zone, some traders weren’t able to fulfill their orders. As such, each time the price goes back to this zone, these orders are filled further weakening the level.

Other applications of supply and demand

Supply And Demand Zones

·         Stop loss and take profit placement

Profit is essentially what every trader wants to achieve. Therefore, tools like the Stop-loss order and Take-profit come in handy to guarantee the safety of your earnings.

The supply and demand zones come in handy when placing your stop-loss orders. Ideally, they should lie further ahead of the supply zone whereas profit targets can be set above the demand zone.

·         Reversal trading

Reversal trading happens at the points where the market trend of an asset or stock changes. It is at the reversal ends where traders are interested in buying into the market or selling—the change in price points to a shift in the balance between supply and demand.

Once a prior market reversal happens, wait for the price level to return to that point and watch for false breakouts. If it happens, then the chances of a reversal occurring are significant. You can use Bollinger bands to come up with high probability trades.

·         Support and resistance

Support and resistance are, in essence, similar to supply and demand zones, and as a trader, these should feature on your charts. While trading, you need to have an acute understanding of price movements so that you can know when to get I to the market and also when to exit the scene in case of unfavorable prices.

Therefore, joining the traditional support and resistance concepts with supply and demand zones should help create a bigger picture of the market price movement.

Finally, a good understanding of the impact of demand and supply on the market is critical if you want to make a profit. These parameters will enable you to get a glimpse of how the price action deviates between an instance of increased demand in the market and vice versa. As such, you should be able to strategically place your entry and exit points into the market with a view of making a profit.

Additionally, supply and demand can be driven by significant market players. So knowing where the smart money traders play could help you make profitable moves as well.

Paul Mukara
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