Supply and Demand Trading – Strategy, Rules etc

Supply and demand — the dynamics between the two are at the heart of any trade, and the same is true of the share market. The push and pull between the two also reflect the price of a security, its availability, and the desire to own such a security. In the share market, technical analysis is used to examine or foresee movement of prices. One of the important aspects of such an analysis is determining supply and demand (S&D) zones. 

What does trading supply and demand zones imply?

Supply and demand zones are at the heart of supply and demand trading. These zones are areas that show  liquidity at a specific price.  The supply zone is also called the distribution zone, while the demand zone is called the accumulation zone.  

Importance of supply and demand zones: Points to consider

– Supply and demand zones are responsible for driving the markets. 

– Trading supply and demand zones helps investors make any purchase or sale decisions.

– When the price of a stock stops falling beyond a specific level and begins to move sideways for a stretch of time, this means that the stock is seeing accumulation and could move up. 

– The distribution zone is the point at which price drop begins and starts its downward movement. 

– To simplify accumulation – a stock that’s bullish is indicative of high demand and is seeing accumulation. Similarly, a stock that’s bearish shows greater supply than demand and is showing distribution.

– Distribution indicates selling-side pressure whereas accumulation is indicative of buying pressure. 

Demand and supply vis-a-vis support and resistance

– Areas of supply-demand leads to support and resistance (S&R) creation. 

– Support and resistance levels are widely used by traders to make decisions. Resistance is the price level on the chart at which an asset’s price increase hits pause. Support is the level on the chart when the downward trend hits pause. 

– Supply and demand zones are spread across a wider area than support and resistance levels. 

– The broader coverage ensures that you can assess price movement in the future more reliably than a single level or line in the case of S&R.

An understanding of both S&R and supply and demand can help when it comes to analysing price charts. 

Any talk of supply and demand trading invariably includes finding supply and demand zones using candlestick charts. Spotting big candles forming in succession on the chart, and establishing the base will help you draw the S&D zones. 

Three things to consider for supply and demand trading

1. The first thing is to identify if you are in a supply zone or a demand one. In the supply zone, the prices are higher than the bid price and in the demand zone, they are lower. The bid price is what a trader is willing to pay for a stock. 

2. The next thing while trading supply and demand zones is to identify the pattern. If you see whether the trend reverses or continues, you can ascertain whether you want to buy or sell, depending on the most active zone. 

3. The third aspect is to get a grasp on rally/drop patterns. When the pattern is indicative of a rally, you may want to sell high and buy low. If you notice a pattern towards price drop, you may look at selling short. 

Supply and demand trading strategy: what to look for

As a trader, you should ascertain what the current socio-economic and political indicators are. Are there any economic or political upheavals that may affect the trading environment and will there be a lot of volatility in the markets? Once that is decided, a trader could take up a supply and demand trading strategy involving breakout or range trading.

Trading the range is a term used to denote that the conditions in the market are stable and not extraordinary. When you are trading the range, selling high or buying low could  be based on S&R levels. 

Trading the breakout is a supply and demand trading strategy when changes in market conditions are expected. In such a scenario, price shifts outside the earlier S&R level, or supply and demand zone. 

Day traders may need to watch for breakout formation of rectangular ranges when markets open or close when liquidity or volatility are higher relatively.

The two ways that you can use for trading S&D include limit order and price action entry. You could wait for the price of a stock to enter a certain zone before placing a limit order. This means you place it at the very edge and then wait or hope for price reversal. A price action is when you use price action (like candlestick patterns) to trade at zones. The latter is used by traders as a more effective strategy.

Conclusion :

Supply and demand trading can be seen as a strategy to understand the zones in which you can look to enter into trades. While support and resistance are defined by key levels of price, supply and demand is defined by a wider price area/zone. The breadth makes it easier to find entries for trades.