Demand Supply: The trader's golden tool you need to know in depth

Do you remember that the sage said, “Price is determined by supply and demand”? But this statement is not as simple as it sounds. In financial markets, demand and supply are not just textbook concepts; they are fundamental mechanisms that drive the movement of stock prices and all assets. Investors who deeply understand supply and demand often can see market turns before others and execute trades more accurately.

Demand and Supply and Price Movements: A Deeper Connection Than Meets the Eye

Stock prices do not fluctuate randomly; they move according to buying and selling pressures that vary over time. When (demand for buying) exceeds (supply for selling), the price tends to go up. Conversely, when more people want to sell than buy, the price drops. What most investors overlook is that demand and supply are not just about the stock itself but are driven by expectations about the company’s future.

If good news comes out, buyers are willing to pay higher prices, while sellers may hold back from selling, causing prices to rise. This process repeats itself with various factors such as earnings reports, company growth, or even decisions to raise capital.

Demand (Demand): The Desire to Buy and the Signals It Reveals

First, to make it easier to understand, think of demand as the buying force in the market. The stronger the demand, the more willing people are to pay higher prices to acquire the stock. In economics, this relationship is called the “law of demand,” which states that price and quantity demanded are inversely related.

Factors influencing demand are diverse and include:

• Economic forecasts
• Liquidity in the financial system (When there is abundant money in the system)
• Investor confidence in the market
• Consumer preferences and emerging market trends

When these factors boost confidence, demand increases, naturally pushing prices higher.

Supply (Supply): The Willingness to Sell and the Seller’s Motivation

If demand is the buying force, then supply is the selling force. Factors that determine supply often have opposite effects to demand because sellers think differently from buyers.

Major shareholders or companies (are the primary sellers) tend to sell more when:

• Prices rise (Relative production costs decrease)
• Production costs decrease
• They expect prices to fall in the future
• Competition in the market increases

The law of supply states that price and the quantity offered for sale are directly related; as prices go up, the number of sellers tends to increase.

Equilibrium (Equilibrium): The Point Where Prices Stop Moving

Imagine the point where demand and supply meet; at this point, the quantity buyers want to purchase equals the quantity sellers want to sell. Prices are in balance, with no pressure to change.

Whenever prices deviate from this equilibrium:

• If prices rise too high, sellers rush to sell, increasing supply and pushing prices back down to equilibrium.
• If prices fall too low, buyers rush to purchase, increasing demand and pushing prices back up to equilibrium.

This explains why prices do not drop to zero or skyrocket infinitely, even though sometimes it might seem possible.

Demand and Supply in Financial Markets: When It Gets More Complex

In financial markets, demand and supply are influenced by even more complex factors than in typical goods markets. For example:

Factors that boost demand: When interest rates fall, investors tend to shift into stocks seeking better returns, increasing demand in the stock market. Additionally, market confidence and liquidity in the financial system play crucial roles.

Factors affecting supply: When companies decide to raise capital or major shareholders want to sell shares, supply increases. Conversely, share buybacks by companies reduce supply.

Applying Demand Supply Zone in Trading: From Theory to Practice

For advanced traders, Demand Supply Zones are techniques that use demand and supply to create actual support and resistance levels. This concept relies on identifying points where prices previously rallied or dropped sharply before consolidating. These points often have buy or sell orders waiting.

There are two main ways to use Demand Supply Zones:

1. Reversal Trading (Reversal) Occurs when prices move strongly in one direction (up or down) and then pause. When new factors come in, prices reverse direction. Examples:

• If prices drop sharply (Drop) and then base (Base), followed by good news, prices may rally (Rally). This is called DBR (Demand Drop Base Rally).
• If prices rally strongly (Rally) and then base (Base), followed by bad news, prices may fall (Drop). This is called RBD (Supply Rally Base Drop).

2. Trend Following (Continuation) Often, after a pause, the trend continues. Traders may buy or sell following the existing trend:

• Uptrend continuation: RBR (Rally Base Rally) — prices rise, pause, then continue upward.
• Downtrend continuation: DBD (Drop Base Drop) — prices fall, pause, then continue downward.

Candlestick Analysis: Visualizing Demand and Supply

Each candlestick reflects the battle between demand and supply:

• Green candle (Close > Open): Demand wins; buyers have more strength.
• Red candle (Close < Open): Supply wins; sellers have more strength.
• Doji (Open ≈ Close): Both sides are balanced; no clear dominance.

On a stock’s price chart, large candles followed by consolidation suggest a Demand Supply Zone is forming and ready for the next move.

Real-World Example of Application

Imagine a stock that recently dropped 20% in a week due to bad news. Traders who understand Demand Supply Zones will look for a pause in the price within a range. At this point, demand and supply are battling anew. When new factors arrive — such as good news or large investors buying — the price breaks out of the range and moves upward. Traders can confidently buy at this breakout point.

Summary: Demand and Supply Are More Than Just Theories

Demand and supply are fundamental mechanisms for all investors and traders, used in both fundamental analysis (whether the company will grow) and technical analysis (where the price is headed). Once you understand them, try applying this knowledge to the stocks you follow. Build experience gradually because, ultimately, the stock market rewards those who understand this game deeply.