What is supply and demand: the main factor that influences the volatility of financial markets

At a fundamental level of economic study, the concept of supply and demand is regarded as the foundation of price determination mechanisms, not only in general theory but also extending to forecasting asset price movements in financial markets. For investors seeking to interpret market signals, understanding what supply and demand are and how to apply this concept becomes essential.

What Are Supply and Demand: Definitions and Basic Mechanics

Supply and demand simply refer to the interaction between buyers’ willingness to purchase and sellers’ willingness to sell. These two sides are not driven solely by instinct but are governed by the rules of price changes.

Demand (Demand)

Demand is defined as the quantity of a good that consumers are willing to buy in exchange for money, without limit. When plotted on a graph, this yields the (Demand Curve), where each point indicates the quantity humans want to purchase at different price levels. Additionally, the curve shows the maximum cash price consumers are willing to pay for a given quantity of goods or services.

The Law of Demand assumes that the desire to buy moves inversely with price—higher prices lead to lower quantities demanded, while lower prices lead to higher quantities demanded. This phenomenon arises from two human characteristics:

Income Effect (Income Effect) refers to how changes in price affect the real value of money. For example, if the price of a good drops—your wallet’s real value increases—you can buy more than before.

Substitution Effect (Substitution Effect) occurs when consumers compare goods with alternatives. A price decrease makes this good seem more valuable, encouraging consumers to switch to buying this good instead of others.

Factors influencing demand beyond price include consumers’ income, preferences, prices of substitute goods, the number of potential buyers, and expectations about future prices. Additionally, seasonal factors, government policies, technological advancements, and consumer consciousness also influence purchasing behavior.

Supply (Supply)

Supply is defined as the quantity of goods that sellers are willing to offer at various price levels. The (Supply Curve) plots this relationship, showing what quantities sellers are willing to supply at given prices. Similarly, the lowest price at which sellers are willing to sell a certain quantity is also revealed.

The Law of Supply is opposite to demand—seller willingness to sell correlates directly with price. Rising prices motivate sellers to supply more, while falling prices reduce the quantity supplied.

Factors affecting supply include production costs, prices of substitute goods, the number of competitors, technological efficiency, future price expectations, natural environmental factors, tax regulations, exchange rates, and access to financing.

Equilibrium Point (Equilibrium)

Demand alone cannot determine prices, just as supply alone cannot. True market prices emerge at the intersection of the demand and supply curves. This point is called equilibrium (Equilibrium), where price and quantity are stable—tending to remain until additional factors intervene.

If the price rises above equilibrium, sellers will offer more goods, but consumers will withdraw, leading to excess supply and downward pressure on prices. Conversely, if the price falls below equilibrium, consumers perceive higher value and want to buy more, while sellers reduce supply, causing shortages and upward price movement.

How Supply and Demand Function in Financial Markets

In financial markets, the demand to buy stocks and the supply to sell stocks are influenced by more complex factors.

Factors Driving Demand

Macroeconomic Growth—determined by interest rates, inflation, and growth forecasts—indicates where investors allocate their capital. Low interest rates often push investors away from savings and toward stocks.

Financial System Liquidity—the availability of money—affects whether goals can be achieved. When central banks inject liquidity into the system, investors have more funds to deploy, often into riskier assets.

Investor Confidence—based on economic, political, and corporate health—shapes willingness to buy. Optimism leads to higher bids; uncertainty prompts cash hoarding.

Factors Driving Supply

Corporate Decisions—such as issuing new shares or buybacks—directly alter the number of shares in circulation. Buybacks reduce supply and wealth, while issuing new shares increases it.

Initial Public Offerings (IPOs)—introduce new securities to the market, expanding supply and potentially stimulating temporary market activity.

Regulations and Requirements—restrictions on selling, lock-up periods after IPOs, and other rules influence how much and when shares are available.

What Is Supply and Demand: Applications in Price Analysis

( From a Fundamental Analysis Perspective

Stock prices reflect the underlying forces of supply and demand. Rising prices indicate demand dominance; falling prices suggest supply dominance. This is not merely about numbers or turning stocks into commodities, but about changing expectations regarding a company’s profits and growth potential. Investors weigh upcoming events—earnings reports, growth rates, structural changes—and interpret news as bullish or bearish, influencing price movements.

) From a Technical Analysis Perspective

Traders use supply and demand as lenses to identify price imbalances. They analyze tools such as:

Price Action and Candlestick Analysis—revealing battles between buyers and sellers. Green candles (close higher than open) indicate strength; red candles ###close lower than open### indicate weakness. Doji candles, with open and close at the same level, suggest indecision. Bullish and bearish engulfing patterns are watched for potential reversals.

Market Trend Analysis—tracking highs and lows. If new highs continue to form, demand remains strong; if new lows appear, supply dominates. Sideways movement indicates balance.

Support & Resistance Levels—acting like magnets. Support (Support) zones are where demand is expected to step in; resistance (Resistance) zones are where supply is concentrated. Breaks through these levels often signal a change in balance and potential new trends.

Examples of Using Demand and Supply Zones in Trading

The Demand Supply Zone technique is often a smart way to gauge where supply and demand are concentrated. Traders look for price ranges where the market has previously reacted strongly, especially before a reversal or breakout.

( Reversal Plays: Trend Reversals

Demand Zone Drop Base Rally )DBR( involves a sharp decline )Drop### from excess supply, followed by a pause (Base), then a rally (Rally) as buyers re-enter. Traders often enter on a breakout above the zone, placing (Stop Loss) orders below the zone.

Supply Zone Rally Base Drop (RBD) starts with a rally (Rally) from excess demand, then a pause (Base), and a subsequent decline (Drop) as supply reasserts itself. Breakdowns below the zone are traded with (Breakdown) entries and stops above.

( Continuation Plays: Trend Continuation

Demand Zone Rally Base Rally )RBR( develops when strong demand causes prices to rally, then pause )Base###, before breaking out again and rallying further.

Supply Zone Drop Base Drop (DBD) occurs when supply dominates, causing prices to drop, pause (Base), and then continue downward once sellers gain control, breaking below the zone.

Summary

What Is Supply and Demand? It is not just an economic theory but a key to understanding market behavior. Whether through fundamental analysis, trend studies, or technical zones, informed investors recognize that behind price movements lie hidden patterns. Deep understanding requires consistent practice with real market data, analyzing which side is winning and predicting where equilibrium will settle. Mastery depends on ongoing training and experience in real trading environments.