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Supply and Demand Trading
What is Supply and Demand? What are the laws of Supply and Demand? What is Supply and Demand trading? How do we use Supply and Demand trading in forex and other financial markets?
Supply and Demand is the heart of a market economy [Capitalism]. Since market economy is based on exchange of goods and services for a value, for it to function there has to be some goods and services on offer [supply] and people who are willing and able buy them [demand]. Supply and Demand in textbooks look as two separate things for study purposes but in reality they are strongly interconnected. One cannot exist without the other.
In an ideal open market, prices are defined by supply and demand, creating a base framework for allocating resources in the most efficient way possible. However, in reality this is not always the case. Monopolies and regulators in certain sectors or systems can define prices as they like regardless of buyers. Prices may also be manipulated by speculators unnaturally thus overriding basics laws of supply and demand.
Figure 1
As it can be seen on the above illustrations, suppliers will produce more when prices going up while buyers will increase their demand when prices are going down. A clear conflict of interest supposes to create a healthy and efficient market.
That's in theory, but in reality we know that there are situations when prices are going up but suppliers will not increase their output unless there are healthy competition. Or buyers will not increase their buying even if prices are going down when they don't have a buying power.
The Textbook Law of Supply
- In order to maximize their profits, suppliers [producers] will be offering more products and services for sale at higher prices.
- The supply increases as prices increase and decreases as prices decrease.
- At certain price levels, when there is a good enough profit margin, suppliers will increase their productions without demanding higher prices in order to increase profits.
The Textbook Law of Demand
- In order to save some money, people will buy more products at lower prices.
- At a lower price, more people can afford to buy more goods and services more frequently, than they can at a higher price.
- At lower prices, people tend to buy some goods and services as a substitute for more expensive ones.
Putting Supply and Demand together
Figure 2
For the purposes of simplicity, Supply and Demand lines are drawn as straight lines. In reality they are curved.
Equilibrium represent the ideal quantity and price match. It's the intersection point where market reached optimum efficiency. For example we have 20 products for sale and 20 people willing to buy. No wastage whatsoever. However, in reality equilibrium cannot be sustained. It's just a temporary point that may be reached from time to time for a brief period. For the life and everything else in this universe to continue we need minus and plus. When all things are equal nothing will happen.
a. Banksters generally acts in sync like one big cartel b. Many funds and insurance companies are extensions of banksters c. Retailers are extremely fractured and can not act in sync.
According to the graph above, retailers represent 18% of $4 trillion a day forex market as of
- That represents hundreds of billions of dollars up for grab on daily basis. Unfortunately, it's mainly grabbed by banksters.
Our task here clearly is to spot banksters and follow them. Forget about novice trader talk. We don't care who is on the other side of our trade as long as we are at the winning side. I have seen many non-novice so called pro traders and institutions loosing large sums to markets. We don't care about losers, our task is to identify winners and follow them. Remember, we do not anticipate but with guidance of the price we try to participate. That's all. Nothing more, nothing less.
How to identify and draw Supply and Demand zones on a trading chart? Well, you don't have to. There is an freely available indicator does it for you automatically. Instead of spending time on drawing and updating your zones manually, it may be more beneficial for your trading to watch PA and check out historical price levels.
For those, who like to understand how zones are defined on a trading chart lets try to demystify it.
There are three types of price moves in markets.
- Going up
- Going down
- Going sideways or nowhere [ranging]
There are some fancy terms circulating around to keep you busy for the purpose of expanding learning process for paid mentoring services or some who likes to keep their website busy with useless stuff. My advice is to keep clear of such complications as they are not aimed to improve your trading. Unfortunately many new traders would be get caught in these useless jargons and end up wasting their time.
What the heck are all these DBD-RBR-DBR-RBD? Apparently they stand for: DBD means Drop Base Drop RBR means Rally Base Rally DBR means Drop Base Rally RBD means Rally Base Drop
Price drops and rise with flags, pennants and various chart - candlestick patterns or without out them. That's it. Why make things complicated? Keep in mind complicated things bound fail sooner or later.
Chart 1
Here we have a chart without any markings other than ask and bid price lines. Where are supply and demand zones?
Supply and Demand zones indicates price turning areas, where price reaches a point that balance will change in favor of other participants. It's the tipping point where imbalance between buyers and sellers is at peak. When imbalance is at its peak, change in direction is bound to follow.
For instance, when balance is on buyers' side we see price is going up. Simply, there are more buyers then sellers at those prices. However, once the price reaches to certain levels, participants start thinking price become too expensive, they start selling at new highs to maximize their profit. Additionally, certain participants would have exhausted their resources during their buying activity and there will be certain participants waiting on certain levels to sell too, which helps to cement a decent supply zone. Now, we have new sellers entering to the market plus some of those buyers closing their buys and joining in as sellers. Price will be travelling down until it finds the demand [where buying interests supersede selling ones].
So, supply and demand zones don't represent magical decision points as some may be stating, but rather zones representing imbalance at its peak. You can pour so much of water into a glass.
Just like in classical supply and demand theory. Suppliers can increase their prices so much, perhaps until there is not enough people willing to buy their products or services at those prices. Unless the supplier is a bone headed with a gigantic ego then he has to reduce his prices to get buyers interested once again.
However, we also know that heavy manipulation is going on in markets. We simply couldn't say natural laws of supply and demand. Remember fake-outs!
Notice where zones are drawn in relation to zigzag highs and lows. It's not a big deal to recognize possible supply and demand zones, is it? I used default settings of the zigzag indicator.
It's fine looking at history and talking on hindsight but how do we know current higher high [hh] is the actual hh?
Chart 4
How to draw zones? There may be different approaches on this but I like how supply and demand indicator draws them.
Chart 5
The key point to watch when drawing a supply or demand zone are HH [higher high] or LL[lower low] as they are starting points of a zone.
- Bull candle at opening starts printing a bear candle [wick] then retraces making new HH. We take HH and the opening point of the bull candle draw the supply zone as shown on the chart 5. Before drawing the zone at least we have to wait for the close of following candle. Without it we wouldn't know our HH is HH as next candle easily can make new HH.
- In situation like this, where LL is made by an engulfing candle we start drawing our demand zone from LL [which is bull engulf candle] to close of previous bear candle instead of close of bull engulf candle. Unlike most other zones with cases like this we use two candles to draw a zone instead of one. Similar situation applies when drawing a supply zone with HH engulfing bear candle. We take HH of the bear engulf candle and opening of the previous candle [please see 2b]
- We see a usual one candle demand zone drawn. However, if you are using supply and demand indicator you will not see the demand zone printed until after candle c closed. Zone is not valid until a candle closed and not touching to zone. So it's always better to wait for confirmation before drawing a zone.
How to trade supply and demand zones? Conventional recommendation is that we wait for price to come back to the zone [preferably untested fresh zone] to take a trade.
- Enter when price deep in the zone with a small stop-loss.
- Wait for PA confirmation then enter with bigger stop-loss.
If we opted for entry type 2, which says wait for PA confirmation once the price hits the zone, then we get two opportunities of entries on this occasion as highlighted on the chart 6 above. Notice, stop-loss size of entry 2a and 2b is bigger than entry 1.
In my trading, I use additional S&D zone entry in addition to above entries. I tend to take trades as or when a new zone established too. Sometimes before zone in sight. I will not go in details for this type of entries as it involves a few things to be taken into account such as reading left PA, spotting viable historical price lines and the way a new zone is created. This type of entries [some calls it "ahead of time trading"] requires a lot of experience and ability to keep in sync with overall market sentiment. Needless to say it's more riskier than conventional entries.
How do we workout PA Config [Price action confirmation] in supply and demand zones? This is where chart and candlestick patterns come in. Remember, we use PA reading in and around the zones to try to determine if the zone will hold or not. I already have written few articles about PA patterns and their use in "Introduction to Price Action" AG forum category and under Education menu "Candle n Chart Patterns". I need to add few more PA patterns yet but what is available so far is more than enough to make a good start. You don't need to learn all PA patterns to be profitable trader. Important ones are more than enough in my opinion. I have started with important ones and most are done. I would recommend you to check them out so that you can fill the PA confirmation puzzle piece in place within the concept of S&D trading.
What time frames are best for supply and demand zones? Supply and demand zones are applicable to any timeframes, in other words supply and demand zones can be drawn and traded on any timeframes. Only thing to keep in mind, supply and demand zones in lower timeframes can be taken out more often and easily than higher time frames. Seasoned S&D traders tend to trade in the direction of higher time frame zones.
What does this mean? For instance, we have price just tested H4 supply zone, zone is holding and price started to move away [down] the zone. In this situation if we are trading on say M5 we'd be looking to sell on decent supply zones of M5 rather than buying at demand zones. Is this means we shouldn't enter any buy orders in such circumstances? Of course not. You can always benefit from decent M5 demand zones too as price rarely moves in one straight line but using supply gives us additional probability in our favor. There are no need to be greedy. We cannot get all the pips. That's until price comes close to possible reaction levels or closing on H4 demand zone. Regardless your trading chart time frame, it's always wise to keep an eye on higher timeframes.
Why some zones doesn't hold? If I knew the answer to this question, I'd say I have the ultimate crystal ball. I could trade with zero losses. Unfortunately, I don't possess such crystal ball. All we can do is check the history, especially historical price lines to see possibilities for the zone may to be taken out or not. The only place to look for possible hints is left of your trading chart. Also keep in mind, during major events such as NFP, ECB press conference, FOMC minutes etc... most zones may be taken out easily.
I may comeback and expand this article further as and when needed.
Supply and Demand
Back To Basics. I wanted to make a simple document about “How to identify a Supply / Demand zone / level”.
This will be my contribution to the PIE / AceGazette community as I will be forever grateful for all the knowledge and skills that has been shared with me...
I wanted to document this file in a very simple fashion so that new traders could be able to identify a Supply/Demand level pretty easily. Traders Helping Traders... Mel
What is a Supply/Demand trading?
K.I.S.S.
Every possible market, whether it is a financial market or not, is being moved by the ongoing supply and demand that is present in this particular market. Supply (sellers ) represents the quantity of products that is available in the market and Demand (buyers) represents the quantity of products that is wanted in the market. When there is more demand than supply, the price of any product is going to rise (demand exceeds supply) and when there is more supply than demand (supply exceeds demand), the price of the product is going to drop.
Selling at Supply or Buying at Demand offers you the best price possible. So why would you want to pay more for a product, service or currency if you can get it at a better and cheaper price?
The Edge
In trading, knowing where a Supply/Demand level is, is knowing and understanding what type of trader or trading account is on the other side of your trade.
Knowing that there are two different types of market participant: The novice trader that belongs to the 95% and the Banks, institutions and Big Money that belongs to the 5% …
A small retail trader isn't able to move price in the market, only institutions and banks are able to do so. The good news is that it is possible to trade in the right direction and to follow the Big Money by simply buying at Demand and Selling at Supply. In other words it is up to you to choose which market participants you want to join!
How to recognize a novice trader?
On both of the examples we clearly see the zones we were looking for, preceding the strong moves. This is a Demand level on the left and a Supply level on the right!
Concretely defining a Supply/Demand zone
Once we found a zone/area like explained above we want to define the base as well as possible by drawing a line on the upper and lower part of the trading cluster. There are two possible ways to define the base (depending on the traders' preference).
Draw the upper line at the high of the cluster, draw the lower line at the low of the cluster.
For Supply: Draw a line at the high of the cluster for the upper part and draw a line at the candles’ bodies (open/close) for the lower part.
For Demand: Draw a line at the low of the cluster for the lower part and draw a line at the candles’ bodies (open/close) for the upper part.
DBD-RBR-DBR-RBD Another way to identify a zone is also to look at DBD-RBR-DBR-RBD
DBD means Drop Base Drop RBR means Rally Base Rally DBR means Drop Base Rally RBD means Rally Base Drop
Let's look at some chart and find an example of each.
Balance VS Imbalance
Now that we know how to identify a Supply/Demand level, we should ask ourselves what the level represents...
When the level/zone is being formed, we consider price to be Balanced. There are as many sellers as buyers present in the market. However a decision to push price lower or higher has to be made.
So sooner or later, the balanced cluster that we saw will become imbalanced as there would be more seller then buyers.
This will cause a rise or drop in price and therefore price will break the cluster.
The best possible scenario is price breaking the cluster in a strong, violent way because if that happens then we would know for sure that there were more buyers/sellers at this precise point.
The Profit Margin
Having a good Supply/Demand level/zone isn't just enough to take a trade blindly … You have to make sure that the potential profit on the trade will be high enough. Make sure that the R:R is good enough by identifying where a previous decision point , Supply/Demand point was.
As a final word, I would like to mention that supply and demand opportunities can be found in every timeframe and in any trading market.
Now that you know what to look for, I suggest that you go and find some examples for yourself on your charts. Try to master this as I believe this is what will take your trading to some new levels... At least it was the case for me...
Trading Supply & Demand (1/5)
Let's first agree that at one point, when you start trading, you feel like a blind one-legged man on a highway. Our goal as traders is then to make our task easy, enjoyable and why not even relaxing. As a wise man recently said on the Ace Gazette forum, "trading is not complex, traders make it complex". Let's not be one of them then.
In order to do so, we need to understand what the bleep is going on day in, day out on your charts. You see bars or candles, up and down, with or without wicks, bodies, gaps: PRICE ACTION. Then you learn some patterns -some of them with crazy names- and start to see clearer: PRICE STRUCTURE. But they are only the expression of a larger force, a key to read what really happens. One thing I will tell you, nothing is random in the market, absolutely nothing. There is no chaos. It is only a question of understanding. And to understand it, you need to decipher it.
So why is price moving up and down like this?
In the Ace Gazette community, we mainly focus on the oldest and still more valid as ever law in economy: THE LAW OF SUPPLY AND DEMAND.
What is it?
"Supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, therefore, is a reflection of supply and demand.
Sam Seiden, who is considered as a supply and demand guru in the tradosphere, wrote: "The foreign currency (Forex) market is where global exchange rates are derived for everyone including market speculators and end users of currency. People and companies buy and sell currency much like you would buy and sell anything else. Strong economies have strong currencies. When we trade the Forex markets, we are trading economies. Therefore, supply and demand for currency depends on the current and expected perceived health of a country's economy. [...]"
You can basically trade any instrument as long as its value can be represented by a chart. Because you will always find some levels of supply and some levels of demand clearly identified. It means: opportunities of buying or selling.
"Understand that there are always two competing forces at work in the market, buyers and sellers. Our goal is to quantify those forces and identify price levels where the imbalance is greatest as this creates change, or movement in price." (Sam Seiden, Lesson from the pros, August 2008)
So, why do we like the principle of SUPPLY AND DEMAND so much? Because on a chart, levels of SUPPLY AND DEMAND (where strong decisions are taken by the big money) are represented by horizontal lines. And horizontal lines are simple enough for the dummies we are (remember, we want our job to be relaxing).
So, horizontal lines. Have you ever heard of SUPPORT AND RESISTANCE? They are wonderful tools for trading that requires only patience, logic, observation and common sense. We will cover this subject with charts in the next post.
Until then, take care and be safe out there.
