Forex Trading Guide To Supply And Demand
In all markets, prices are governed by the laws of supply and demand. As Forex traders we must understand these forces and how they relate to our analysis of the market.
Supply represents selling within a market and demand represents buying, thus supply and demand are all about the interaction between buyers and sellers.
This relationship between the two sides of the market determines the price of a financial instrument.
How it works
Since constant buying and selling occurs in the Forex market, supply and demand are always at play.
- When supply is equal, or almost equal, to demand the market is in equilibrium and prices will not change much.
- If demand (buying) is greater than supply (selling) then prices increase.
- If supply (selling) is greater than demand (buying) then prices will decrease.
As you can see, participants determine the supply and demand of the market. By extension, this determines the price.
Trading supply and demand
The above explanations sound great but us traders need methods to gauge when these forces could shift so we can take advantage of these opportunities.
Enter support and resistance.
Traders looked at charts and realized that shifts in supply and demand usually took place at certain prices, this gave birth to support and resistance.
This gave a visual representation of the forces at play and when they could change. Consequently, support and resistance became, and still is, the foundation of technical analysis.
Support and resistance
Please do not make the mistake that most traders do! Often support and resistance are referred to as “levels” but the market does not turn at exact prices, like many think.
Rather support and resistance act in “zones” meaning the market usually turns near a certain price.
Support and resistance zones
There is nothing wrong with using the term level, but as a technical analyst, you should always be thinking of it as a zone of influence.
But how can you trade support and resistance?
You can use these levels/ zones to enter in the direction you believe the market is headed – This could be with the trend, a reversal of the trend, or a reversal within a range.
Reversal trade within range
Although it is the granddaddy, support and resistance is not the only weapon at your disposal.
All forms of technical analysis are designed to give insight into supply and demand so we can determine when probabilities favor a trade. Next up I will break down a few of the best tools.
Technical analysis to gauge supply and demand
Candlesticks give one of the best indications of supply and demand, this is because they provide the important price points (open, close, high, low) of the specified period.
You have a huge amount of information from those 4 points which allows you to judge the flow of the market.
Candlesticks with large real bodies in one direction show strength from that side of the market, this is because the bulls/ bears were able to push price a lot in their direction. The candlestick close is important when considering the strength of the signal.
Large wicks, followed by a close in a definitive direction tell us there was a rejection of a certain level/ price because the side that initially pushed price in their direction, was unable to sustain their control of the market.
Known as dynamic support and resistance, trendlines define which side is in control of the market. An upward sloping trendline shows demand vs a downward sloping trendline showing supply.
Trendline showing direction
Trendline breaks indicate shifts in supply and demand because the participants on that side were unable to push the market further in their direction.
Trendline break indicating shift
3. Indicators (RSI and Stochastic)
Overbought means momentum on the buy-side is decreasing, and supply (selling) could overpower the buyers. Oversold means that momentum on the sell-side is decreasing, and demand (buying) could overpower the sellers.
Now you know what tools are best to analyze supply and demand, let us quickly discuss the relationship with the different market environments.
Relationship with market environments
Buyers and sellers are either imbalanced or in a state of relative equilibrium, this is what determines the current market environment.
Ranges are the result of equilibrium.
Trends are the result of an imbalance.
When demand overpowers supply, the market will trend up.
When supply overpowers demand, the market will trend down.
Factors that influence supply and demand in Forex
- You can use zones of supply or demand when considering your exits i.e. where to place your stop losses and/ or take profits.
- Look for important price points on the larger timeframes and execute on the lower timeframes, check out Multiple Timeframe Analysis for more on that.
- Trading with the trend comes with a higher probability because these forces are already working in that direction.
Thanks for sticking with me, I hope you have learned something from this article. This was geared more towards the principles of supply and demand, but I am sure you will be able to take the theory/ examples and apply them in your Forex trading.
Until next time.