Supply And Demand Trading Strategy
The supply and demand strategy is built on the idea of marking the zones where the price of a financial asset made a strong move up or down, and treating them as supply and demand areas. From there you decide whether to buy or sell the asset based on the market pressure at that level. It helps to understand Reversal Zone Trading Strategy.
The zone where price developed and rose sharply is marked as a supply area that supports selling, while the zone where price dropped hard is marked as a demand area that supports buying.
The rule behind the supply and demand strategy
In short, supply in the market refers to the quantity of an asset that is available, while demand refers to how much of that asset people want to buy. When the supply of an asset increases, its value falls accordingly. Conversely, when supply falls, its value rises.
When demand for an asset increases, its value rises accordingly, and when demand falls, its value drops.
Because the supply and demand rule is simple, many traders look for these supply and demand zones or levels on a given asset to get a better idea of whether price is likely to rise or fall, so they can open trades in line with the supply and demand levels marked on the chart.
How to identify supply and demand zones
Supply = Sell
Demand = Buy
With the supply and demand strategy it is not quite that simple, but that is the general idea. A supply zone usually points to rising selling pressure, because that selling pressure pushes the asset’s market value down.
Supply and demand zones are areas you can spot on the chart of an instrument or asset where price has been reached several times before, or that formed after sharp moves. Unlike support and resistance, up close these levels look more like areas than precise lines.
Building a supply and demand strategy in trading
Using the supply and demand rule, we always aim to buy low and sell high, meaning buy in demand zones and sell in supply zones. So we trade against the direction price is moving in, based on an estimate of how price may move and where it is close to reversing.
When a break happens in a supply or demand zone, that is your entry point for the trade. This is called the action moment, and the breakout level is where a pattern or candle confirms an imbalance in supply and demand and prices start to move, as shown in the example below.
As we can see here, orders are expected to be filled at the same price level once an imbalance occurs, so we have a statistical edge that lets us infer there will be another imbalance in the market in that area.
How to decide the take-profit level in the supply and demand strategy
- The first take-profit in a sell trade is the resistance level (the demand zone).
- The first take-profit in a buy trade is the support level (the supply zone).
As you watch your chart for a new support level to form, you should expect a new demand zone to appear where you set up the trade. Once it is marked on the chart, you can set take-profit at that level accordingly. The same principle applies to the opposite market direction.
At that level you can close your trade fully or partly and wait for the next level to set up new entries.
How to place a stop-loss in the supply and demand strategy
- The suggested stop-loss should sit just below or above the edge of the marked supply or demand zone. This price point is known as the base.
- When trading a supply zone, this is the start of the large candle that began forming the zone, along with the neighbouring group of candles.
- When trading a demand zone, this is the top end of the large candle that began forming the zone, along with the neighbouring group of candles.
- Traders working with a supply and demand strategy like this need to pay attention to these two decisive levels that appear on the charts.
How can I set limit orders with supply and demand zones?
Trading with a supply and demand indicator strategy is useful because it works on pre-defined levels and shows the potential location where price may react in the future.
You can also set pending orders automatically for when price reaches these future price levels. This lets you set up trades using limit orders and wait for the market to return to these levels again without sitting in front of the chart.
Buy limit orders: once you see a take-profit level form on the chart, you can set a buy limit order to enter the trade when price returns to the marked supply zone. Because you defined all your trade setup levels in advance, you can simply place your limit orders and wait for the market to reach the levels you want.
Sell limit orders: this works the same way as a buy limit order. You can place a short sell to enter the market automatically when price reaches the demand zone again. So you look for price moves that drift far away and stay away from the supply zone for a while. When price reaches that level, there is a strong chance your trade returns to the take-profit levels you set at the supply zone.
Confirming a trade entry with the supply and demand strategy
The pending-order method is not the most effective approach, since a supply or demand zone will not always react and produce reversals. Sometimes the reaction does not last long and can be just a small bounce before price continues in the same direction. Many events can knock supply and demand zones out of action, such as major economic releases or even inaccurate analysis, so always watch your chart and the economic calendars.
A good way to confirm your entry point is to wait for the zone’s formation to be validated, such as a strong reaction from the level and a strong push away from it. It could be a pullback that offers a good trade opportunity, and if not, remember that more opportunities will come in the market.
The supply and demand strategy is one of the core strategies used in trading. It focuses on the old laws of supply and demand and how price moves in the forex market.
The basis of the supply and demand strategy is that the amount of available liquidity and buyers’ willingness to take it are what drive price. This defines the areas on the chart where demand outweighs supply in the demand zone, leading price to rise, or where supply outweighs demand in the supply zone, leading price to fall.
With the supply and demand strategy, most traders wait for price to enter these zones, where major buying or selling activity took place, before they enter a long or short position themselves.
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Frequently asked questions
What is supply and demand in trading?
Supply is the quantity of a financial instrument, for example shares, that is available in the market, and demand is the quantity of the instrument that a trader wants to buy. The more supply there is, the lower its price, and the less supply there is, the higher its price.
What are supply and demand zones?
They are the rise and fall areas that come before sharp, sudden price moves for a given financial asset or instrument. They are spotted on the chart and used to decide a position on the instrument, either selling or buying.
How do I identify supply and demand?
Supply and demand are tied to the market value of the financial asset. Supply is when selling pressure occurs and the market value falls, and demand is when there is buying pressure, which raises the market value.
What does the ask (offer) price mean?
It is the highest price a buyer offers to buy a given financial instrument. Prices are ranked from highest to lowest for the share, and the more supply there is, the lower the share price.
What is the concept of demand?
Demand is a trader’s willingness to buy a financial instrument relative to the ability to buy. Demand is tied to price and quantity: the larger the quantity supplied, the lower its price, which lets the consumer acquire it if the willingness and purchasing power are there.
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