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The Complete Guide to Supply and Demand in Forex
Supply and Demand Forex – The driving force behind changes in price is supply and demand. When there are more buyers than sellers, the market price will move up. Conversely, when there are more sellers than buyers, the market price will move down. When buyers and sellers are more or less even, the market will range. These simple concepts are very powerful and allow us to analyze naked charts in order to determine where the price is likely to go.
Since the current price is determined by past prices, this is a very simple method of technical analysis and a highly successful trading style that makes it possible to identify a specific entry price, and a supply zone or demand zone. Stop-loss and take-profit levels are also easily identifiable.
Supply and demand in forex trading (SD for short) provides a simple no-brainer system that gives good profits. All this without all the complexity of technical indicators, but rather through the interpretation of the bare price action itself.
What are Supply and Demand? A Definition
The patterns that prices make on a market chart are created by the activity that occurs in that market — namely buying and selling. This buying and selling are dependent upon supply and demand. To simplify, demand is represented by buyers, while supply is represented by sellers.
Say, for example, that a company releases a new tablet computer. If all these tablets can’t move at the price at which they are being sold, then the price will drop. It will continue to drop until prices find a balance with what buyers are willing to pay. Conversely, if there are more buyers than there are tablets, the price will move up.
Financial instruments like currency pairs and stocks are no different. When buyers balk at paying 1.125 EUR for 1 USD, the price will go down. And when they are eager to pay that price, the price will go up.
Supply and demand trading is a system for identifying zones of supply and demand that we can use to make trades that give us a statistical advantage.
We created four videos on Supply and Demand Forex that explain in-depth how to trade the method
Reading The Story Of The Market – Part 1 – Order Flow
How and Why are Supply and Demand Zones Created?
Supply and demand zones are defined when an imbalance in the buyers and sellers occurs.
An easy way to visualize this is by thinking of supply as a commodity product. Let’s say oranges. And we can think of demand as shoppers.
Imagine that this was a good year for orange farmers. They have produced a lot of oranges. Yet the shoppers will be willing to buy just enough. That means there is more supply of oranges than demand for oranges. If the farmers wish to sell out their inventory, they would have to stimulate buyers to buy more. The easiest way to do so is by reducing the price of oranges. Now shoppers will consider buying more because the oranges are discounted, or because now they can afford more. The price will continue to drop until all the oranges have found buyers. That would be the balance point — the point at which there are enough buyers for the supply of oranges in the market.
Toward the end of the orange season, the farmers clear their inventory and a smaller supply of oranges is now on the market. The same number of shoppers consume oranges as they normally do — demand has returned to normal. There are fewer oranges to sell, so the price will go up. It will go up to the level where every buyer that is willing to pay a higher price will find an orange to buy. Under these market conditions, that level is the balance level.
As long as there is enough commodity to whet the appetite of buyers, the price of that commodity will remain within a tight range. When one side exceeds the other in volume, for example, if there are more offers than buyers — an imbalance will cause prices to change until it reaches balance once again. This imbalance is identifiable on the price charts as a significant move from the current price level.
In the financial markets, the asset is the product and the rate value is the demand. If the price is cheap, it means there is more supply than there are willing buyers. If the product is getting expensive, that means there is more demand (buyers) for less supply.
Supply and Demand Forex Analysis
The supply and demand concept is timeless. It will always be the simplest, most atomic way of explaining why price changes. This is because the market is the place where sellers and buyers meet to conduct the business of exchanging the product for cash.
By understanding the supply and demand concept, it will be very simple to spot SD zones on charts. Although this would be a hindsight observation, it will give us a good hint of where to look for our trades in the future.
It is key to understand that the theory of supply and demand forex trading is based on analyzing and defining zones in the past. These zones determine where should we expect the price to react in the future.
Why should we expect a price reaction? Let’s get back to oranges and shoppers. Say, for example, you could buy one orange at a price of $1. We have only five oranges to sell, but buyers are asking for ten oranges to buy. So five oranges were sold at $1, and no sellers were found for the five remaining orders. Remember these five unsatisfied orders for later.
Obviously, the price would jump up to $1.50 per orange to attract more producers to provide more supply. Later on, supply exceeds the buyer’s willingness to pay for the expensive oranges, and the price drops back to $1.
The five orders at $1 per orange are assumed to be there waiting. Their request will be filled immediately, as they are first in line for oranges at the rate of $1.
Something similar happens in the Forex market. When the price changes, we can assume a high likelihood of unfilled orders. These orders are waiting and they will be the first to be executed once the price returns for the first time to the demand level of $1.
in this video, we Demonstrate Supply & Demand Analysis
How to Identify Supply & Demand Zones on Price Charts
It’s easy to see supply and demand on charts in any timeframe, once we understand supply and demand balance and imbalance.
First, we look for a balanced zone. This is a ranging consolidation zone of price. It represents buyers and sellers who are at peace and in balance. Every product offered at this price finds a buyer. For every demand to buy, there is a seller. The price is not negotiated and everyone is happy with price levels and stocks.
Next, we look for a breakout of that range. If it breaks out upward, it represents an increasing demand and a lack of sufficient supply. If it breaks out lower, that represents an increasing supply and buyers reducing their demand.
How to Identify Demand Zones on Price Charts
To identify a demand zone on a chart, we are looking for a large candle or series of candles in the same direction moving up and away from a ranging price zone. When this occurs, the area underneath the point where the candle breaks through the body of the past two candles is a demand zone. As you can see in the graph.
How to Identify Supply Zones on Price Charts
The method for identifying supply zones on charts is similar to identifying demand zones, only reversed. You will be looking for a large candle or series of candles that fall beyond the bodies of the previous two candles in a downward direction. The area above this is a supply zone.
At this point, we are looking for a significant move in the direction of the large candle. The stronger the move, the stronger the demand or supply zone is. It also suggests that the price will move in the same direction again when the price returns to this level in the future.
We want the price to stay away for a while. If it comes right back, it is not a significant move. In other words, we want the move to be significant in both price and time. We now know where to enter the market and where to set our stop-loss and take-profit.
How to Trade Supply and Demand Zones
Planning The Entry
Simply enough, using the understanding of supply and demand, we would always be buying low and selling high — buying at demand zones and selling at supply zones. Therefore, we will be buying against the direction the price is moving, because we have a good estimation for when the price is about to reverse.
The point of entry for the order is at the breakout level of the zone. This is known as the origin level. Thinking in terms of supply and demand, the breakout level is where we can see a confirmation of imbalance. One side has the upper hand on the other.
As explained above, once an imbalance occurs, orders are waiting to be filled at this very price level. So we have a statistical edge to assume another price imbalance will occur at that level once again.
The stop loss should be placed just beyond the extreme end of the zone. This price level is known as the base.
For a supply zone, this would be the extreme low produced by the large candle and the group of candles near it.
For a demand zone, this would be the extreme high produced by the large candle and the group of candles around it. This point corresponds with the top of a demand zone and the bottom of a supply zone.
The first take-profit is the first demand level when shorting and the first support level when going long. So, when a new support level forms, you should set up your trade and wait for the next demand level to form. Once it has formed, you would set up a take-profit — whether partial or full.
Perhaps if your trade is against the larger trend, it would be prudent to close the position entirely. Or you could only close out a portion of the trade. Then when you hit a new demand or supply level within the constraint of the current stop-loss, you could enter a new trade — and so on.
The same theory holds true for the reverse action.
When large volumes are gathered at a level above the price, the supply increases. This can cause the price to drop sharply when it hits the supply zone.
Traders engaging in supply and demanding trading like this need to be on the lookout for these two important levels in their charts. The demand zone and the supply zone.
Limit Orders – Set and Forget Method
Supply and demand forex trading is based on the predefined price. This is the beauty and the power of trading SD. It provides, with high probability and accuracy, the location where the price will be reacting in the future.
With this information, it would be very simple to set pending orders to be automatically triggered once the price hits a future price level. This allows us to set up trades using limit orders, and let the market develop at its own pace. You can wait in comfort for your trades to be triggered, whenever it happens, with no further effort.
Buy Limit Orders
Once a take-profit level has formed, you have nothing stopping you from setting up a buy limit order to enter the position when the price returns to the identified supply level.
Since you know all the key parameters for the trade. you can simply set up limit orders and specify the entry, stop loss and take-profit.
Sell Limit Orders
Similarly to the buy limit order, you can set up a limit order to automatically enter a sell market order when the price re-enters the demand zone.
To sum it up, look for a price move that speeds away travel far away and stays away for a long time. When the price arrives back to the original level, the odds are high that it will go back up again.
The “set and forget” method has some disadvantages. A supply and demand zone will not always react with a reversal. Sometimes, the reaction will be weak and quick. There are several events that can wash out SD zones, such as economic news releases or even an error in our analysis.
A good method to overcome this is to wait for a confirmation that validation of the zone is “red hot.” A good idea for confirmation is to wait for the first reaction on the level, to see if the price is strongly pushed away off that level. If it is, wait for a pullback retracement and hop in. If not, leave it alone.
Automatic SD indicator
We are attaching an automatic supply and demand identifier indicator for MT4. Please note that it is an indicator that is timeframe sensitive. It doesn’t show all of the relevant key levels. It may also provide too many levels. Therefore, use it only after you have a good understanding of how to manually draw SD levels yourself, and don’t blindly depend on this indicator for trading.
Download Free Supply & Demand Indicator
Supply and Demand Forex pros and cons
The nice part about trading in a supply and demand system is that the price levels are predefined which means you set them and wait. This gives you a well-deserved break from the screen without having to monitor every single movement waiting to make a trade.
Related to screening time, when you trade with this method, you also clearly see price move with reason and logic. There are clear machinations at play when traders are buying and selling within supply and demand zones.
The reason it’s clear and logical goes back to the beginning of the article. The method is governed by perhaps the most fundamental principle in economic theory.
If you can successfully execute this strategy, there aren’t many cons here. The only thing to really be aware of is that this method isn’t a stand-alone, trading plan in itself. Supply and demand trading should be incorporated as part of your larger, more comprehensive market strategy.
Supply and Demand Forex Conclusion
The Supply and Demand trading technique has great advantages. It can be traded as “set and forget” with pending orders. You know all the trade values ahead of time (entry, stop loss, take-profit) and it provides a great RRR (return-risk ratio).
However, like all techniques, it must be practiced and mastered. There are many caveats to be aware of. It takes time to learn how to handle them all. We advise you to learn more and understand that it is not quite as simplistic as it seems, nor is it a pure systematic trading strategy. It requires deeper learning.
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