Supply and Demand Trading What is Supply and Demand? What are the laws of o f 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 ased on exchange of goods and ser!ices for a !alue" for it to function there has to e some goods and ser!ices on offer [supply] and people who are willing and ale uy them [demand]. Supply and Demand in textooks look as two separate things for study purposes ut in reality they are strongly interconnected. #ne cannot exist without the other. $n an ideal open market" prices are defined y supply and demand" creating a ase framework for allocating resources in the most efficient way possile. Howe!er" in reality this is not always the case. %onopolies and regulators in certain sectors or systems can define prices as they like regardless of uyers. &rices may also e manipulated y speculators unnaturally thus o!erriding asics laws of supply and demand.
'igure ( )s it can e seen on the ao!e illustrations" suppliers will produce more when prices going up while uyers will increase their demand when prices are going down. ) clear conflict of interest supposes to create a healthy and efficient market. *hat+s in theory" ut in reality we know that there are situations when prices are going up ut suppliers will not increase their output unless there are healthy competition. #r uyers will not increase their uying e!en if prices are going down when they don+t ha!e a uying power. The Textbook Law of Supply
(. $n order to maximi,e their profits" suppliers [producers] will e offering more products and ser!ices for sale at higher prices. -. *he supply increases as prices increase and decreases as prices decrease. . )t certain price le!els" 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
(. $n order to sa!e some money" people will uy more products at lower prices. -. )t a lower price" more people can afford to uy more goods and ser!ices more fre/uently" than they can at a higher price. . )t lower prices" people tend to uy some goods and ser!ices as a sustitute for more expensi!e ones. &utting Supply and Demand together
'igure 'or the purposes of simplicity" Supply and Demand lines are drawn as straight lines. $n reality they are cur!ed. 0/uilirium represent the ideal /uantity and price match. $t+s the intersection point where market reached optimum efficiency. 'or example we ha!e -1 products for sale and -1 people willing to uy. 2o wastage whatsoe!er. Howe!er" in reality e/uilirium cannot e sustained. $t+s 3ust a temporary point that may e reached from time to time for a rief period. 'or the life and e!erything else in this uni!erse to continue we need minus and plus. When all things are e/ual nothing will happen.
Sellers and uyers needs to keep fighting for the price to sell and uy. Sellers will want maximum possile high price while uyers will e looking maximum possile lowest price for the goods and ser!ices. Welcome to the markets. Depending on the economic climate supply and demand cur!es can mo!e or shift either way" thus altering price and /uantity structure. *he ao!e is asolute asics of Supply and Demand in open markets. %y intention is to utili,e them on ways to apply Supply and Demand in trading rather than detailed study of Supply and Demand itself. What is Supply and Demand trading?
*rading in financial instruments" whether it+s 'orex" 'utures or 0/uities takes place in markets. We already know that for markets to function it needs sellers and uyers. Supply and Demand is all aout spotting where uyers and sellers are sitting on our trading charts. Howe!er" we as a retail traders do not ha!e access to current order flow. We cannot spot them within their current position. )ll we can do is loo king ack [left of our charts] to history and define pre!ious Supply and Demand ,ones with the expectation that in those ,ones will still exist some serious uyers and sellers. 4sing lagging Supply and Demand information" we are making our trading decision ased on historical data" not the current definiti!e data. We also know that what has happened in the past will w ill not necessarily repeat at present time. We ha!e proailities to deal with. We use price action chart and candle patterns to impro!e proailities in our fa!or. *here is one important difference etween classic Supply and Demand theory and Supply and Demand that applies to traders. While on classic approach suppliers generally stays as suppliers in the process of exchange" howe!er in trading we can not identify certain participants as sellers or uyers. )ll participants in trading can e uyers or sellers at any one time" e!en at the same time. 5ememer" trading means uying and selling. 6uyers doesn+t turn into sellers and !ise !erse. *hey already are oth. When applying Supply and Demand in trading keep this in mind. 'oreign7exchange 'oreign7exchange market has many participants in !arious class and si,e.
'igure )s we can see from the ao!e graph 6anksters are firmly in control of 'orex. $n spite of healthy growth of retailers market share" anksters will remain in control. 0!en if market share of retailers hit similar le!els of anksters" they will still e in control.
a. 6anksters generally acts in sync like one ig cartel . %any funds and insurance i nsurance companies are extensions extensions of anksters c. 5etailers are extremely fractured and can not act in sync. )ccording to the graph ao!e" retailers represent (89 of :; trillion a day forex market as of -1((. *hat represents hundreds of illions of dollars up for gra on daily asis. 4nfortunately" it+s mainly graed y anksters. #ur task here clearly is to spot anksters and follow them. 'orget aout no!ice trader talk. We don+t care who is on the other side of our trade as long as we are at the winning side. $ ha!e seen many non7no!ice so called pro traders and institutions loosing large sums to markets. We don+t care aout losers" our task is to identify winners and follow them. 5ememer" we do not anticipate ut with guidance of the price we try to participate. *hat+s all. 2othing more" nothing less. How to identify and draw Supply and Demand zones on a trading chart?
Well" you don+t ha!e to. *here is an freely a!ailale indicator does it for you automatically. $nstead of spending time on drawing and updating your ,ones manually" it may e more eneficial for your trading to watch &) and check out historical his torical price le!els. 'or those" who like to understand how ,ones are defined on a trading chart lets try to demystify it. *here are three types of price mo!es in i n markets. (. eep in mind complicated things ound fail sooner or later.
Chart ( Here we ha!e a chart without any markings other than ask and id price lines. Where are supply and demand ,ones? Supply and Demand ,ones indicates price turning areas" where price reaches a point that alance will change in fa!or of other participants. $t+s the tipping point where imalance etween uyers and sellers is at peak. When imalance is at its peak" change in direction is ound to follow. 'or instance" when alance is on uyers+ side we see price is going up. Simply" there are more uyers then sellers at those prices. Howe!er" once the price reaches to certain le!els" participants start thinking price ecome too expensi!e" they start selling at new highs to maximi,e their profit. )dditionally" certain participants would ha!e exhausted their resources during their uying acti!ity and there will e certain participants waiting on certain le!els to sell too" which helps to cement a decent supply ,one. 2ow" we ha!e new sellers entering to the market plus some of those uyers closing their uys and 3oining in as sellers. &rice will e tra!elling down until it finds the demand [where uying interests supersede selling ones]. So" supply and demand ,ones don+t represent magical decision points as some may e stating" ut rather ,ones representing imalance at its peak. ou can pour so much of water into a glass. @ust like in classical supply and demand theory. Suppliers can increase their prices so much" perhaps until there is not enough people willing to uy their products or ser!ices at those prices. 4nless the supplier is a one headed with a gigantic ego then he has to reduce his prices to get uyers interested once again. Howe!er" we also know that hea!y manipulation is going on in markets. We simply couldn+t say natural laws of supply and demand. 5ememer fake7outsA
Bets use good old ,ig,ag indicator as a !isual helper to see peeks and drops clearly rather than polluting our heads with D6D75657D65756D stuff.
Chart With the help of ,ig,ag indicator we can identify ma3or and minor price turning ,ones including older ones with ease. 2ow lets add supply and demand ,ones to the chart ignoring minorweak ,ones.
Chart
2otice where ,ones are drawn in relation to ,ig,ag highs and lows. $t+s not a ig deal to recogni,e possile supply and demand ,ones" is it? $ used default settings of the ,ig,ag indicator. $t+s fine looking at history and talking on hindsight ut how do we know current higher high [hh] is the actual hh?
Chart ; How to draw ,ones? *here may e different approaches on this ut $ like how supply and demand indicator draws them.
Chart *he key point to watch when drawing a supply or demand ,one are HH [higher high] or BB[lower low] as they are starting points of a ,one. (. 6ull candle at opening starts printing a ear candle [wick] then retraces making new HH. We take HH and the opening point of the ull candle draw the supply ,one as shown on the chart . 6efore drawing the ,one at least we ha!e 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. -. $n situation like this" where BB is made y an engulfing candle we start drawing our demand ,one from BB [which is ull engulf candle] to close of pre!ious ear candle instead of close of ull engulf candle. 4nlike most other ,ones with cases like this we use two candles to draw a ,one instead of one. Similar situation applies when drawing a supply ,one with HH engulfing ear candle. We take HH of the ear engulf candle and opening of the pre!ious candle [please see -] . We see a usual one candle demand ,one drawn. Howe!er" if you are using supply and demand indicator you will not see the demand ,one printed until after candle c closed. Eone is not !alid until a candle closed and not touching to ,one. So it+s always etter to wait for confirmation efore drawing a ,one. How to trade supply and demand zones?
Con!entional recommendation is that we wait for price to come ack to the ,one [preferaly untested fresh ,one] to take a trade. (. 0nter when price deep in the ,one with a small stop7loss. -. Wait for &) confirmation then enter with igger stop7loss.
Chart F #!iously on hindsight entry ( would ha!e een the est one ut on li!e charts at this point we don+t know if price is going to e contained in the ,one or not. We could simply take the trade and hope for the est or look for something to indicate possiilities of price turning" ,one holding. $n my case first thing $ see is signs of 5S$ di!ergence" and that would most likely e enough for me to take the trade [entry (] as the risk is minimal" rather than del!ing into deep chart analysis. #n the other hand when we check left we don+t ha!e clean clear arri!al" ,one has een tested efore twice which means it+s not a fresh ,one. )re there still decent uyers? Some negati!e !ies against taking trade. $f we add a hori,ontal in the ,one and check farther left we see some positi!e history.
Chart G
$f we opted for entry type -" which says wait for &) confirmation once the price hits the ,one" then we get two opportunities of entries on this occasion as highlighted on the chart F ao!e. 2otice" stop7loss si,e of entry -a and - is igger than e ntry (. $n my trading" $ use additional SD ,one entry in addition to ao!e entries. $ tend to take trades as or when a new ,one estalished too. Sometimes efore ,one in sight. $ will not go in details for this type of entries as it in!ol!es a few things to e taken into account such as reading left &)" spotting !iale historical price lines and the way a new ,one is created. *his type of entries [some calls it Iahead of time tradingI] re/uires a lot of experience and aility to keep in sync with o!erall market sentiment. 2eedless to say it+s more riskier than con!entional entries. How do we workout ! "onfig #rice action confirmation$ in supply and demand zones?
*his is where chart and candlestick patterns come in. 5ememer" we use &) reading in and around the ,ones to try to determine if the ,one will hold or not. $ already ha!e written few articles aout &) patterns and their use in I$ntroduction to &rice )ctionI )< forum category and under 0ducation menu ICandle n Chart &atternsI. $ need to add few more &) patterns yet ut what is a!ailale so far is more than enough to make a good start. ou don+t need to learn all &) patterns to e profitale trader. $mportant ones are more than enough in my opinion. $ ha!e started with important ones and most are done. $ would recommend you to check them out so that you can fill the &) confirmation pu,,le piece in place within the concept of SD trading. What time frames are est for supply and demand ,ones? Supply and demand ,ones are applicale to any timeframes" in other words supply and demand ,ones can e drawn and traded on any timeframes. #nly thing to keep in mind" supply and demand ,ones in lower timeframes can e taken out more often and easily than higher time frames. Seasoned SD traders tend to trade in the direction of higher time frame ,ones. What does this mean?
'or instance" we ha!e price 3ust tested H; supply ,one" ,one is holding and price started to mo!e away [down] the ,one. $n this situation if we are trading on say % we+d e looking to sell on decent supply ,ones of % rather than uying at demand ,ones. $s this means we shouldn+t enter any uy orders in such circumstances? #f course not. ou can always enefit from decent % demand ,ones too as price rarely mo!es in one straight line ut using supply gi!es us additional proaility in our fa!or. *here are no need to e greedy. We cannot get all the pips. *hat+s until price comes close to possile reaction le!els or closing on H; demand ,one. 5egardless your trading chart time frame" it+s always wise to keep an eye on higher timeframes. Why some zones doesn%t hold?
$f $ knew the answer to this /uestion" $+d say $ ha!e the ultimate crystal all. $ could trade with ,ero losses. 4nfortunately" $ don+t possess such crystal all. )ll we can do is check the history" especially historical price lines to see possiilities for the ,one may to e taken out or not. *he only place to look for possile hints is left of your trading chart. )lso keep in mind" during ma3or e!ents such as 2'&" 0C6 press conference" '#%C minutes etc... most ,ones may e taken out easily. $ may comeack and expand this article further as and when needed.