Price Action Trading Strategy: Supply & Demand Zones

The law of supply and demand is a theory that aims to clarify the relationship between the availability and desire for a product, such as a security, and its price. Hakan Samuelsson and Oddmund Groette are independent full-time traders and investors who together with their team manage this website. They have 20+ years of trading experience and share their insights here. Draw supply and demand lines by identifying zones and using a rectangle tool to draw from left to right.

We can use the stock market to give some great supply and demand examples with buyers and sellers who want different prices. What factors, then, cause beaxy exchange review the demand or supply curves for shares of stocks to shift? The most important factor is a change in the expectations of a company's future profits.

One such principle involves the formation of supply and demand zones, which are indicative of impending market trends. Government policies also play a role in shaping supply and demand in the stock market. Changes in regulations or tax laws can have significant impacts on companies’ profitability and overall market sentiment. For instance, if there are favorable policies that encourage business expansion or provide tax incentives, it could stimulate investment activity and drive up stock prices.

But make sure to carefully study price charts to find stocks that are breaking out of proper bases or rebounding from key chart levels. When a stock tops a buy point, ideally volume will be at least 40% above average. When a share price spikes in big trading volume, this is a clear sign of institutional demand. It is a key indicator that mutual fund managers and other big money buyers, who account for most trading in the stock market, are snapping up a stock.

As the base formation completes and prices start to decline from the zone, the Supply zone is formed. DBD zones happen when the price drops, undergoes consolidation, and then drops once more. RBR zones materialize when the price rallies, forms a base or consolidation, and then rallies again. Fresh zones that haven’t been tested are more likely to provoke price reactions compared to zones that have already been tested.

Technical Factors

According to Haight, while you don’t need to obsess over every little movement in the stock market, it’s worth paying attention to what’s going on with current and potential investments. Part of these earnings may be distributed as dividends, while the remainder will be retained by the company (on your behalf) for reinvestment. We can think of the future earnings stream as a function of both the current level of earnings and the expected growth in this earnings base. Like in any form of technical analysis or trading strategy, there are strong signals and weak signals. To get the best trading results, we need to ignore the weak signals and take the strong ones. This also impacts you when trading – if you’re trying to buy stock with a “Market Order“, you will get the “Ask Price”, or how much the current sellers want for their stock.

You can think of these zones as the boundaries within which traders are willing to buy and sell assets, effectively forming a price range until a new imbalance emerges. Well, traders who use it claim that it works more often than not and makes them money overall. But being a subjective strategy, different traders use them differently, so it may work for some people and not work for others depending on how they use it and the timeframe they trade on.

1. In contrast, basic necessities will be relatively inelastic in price because people can't easily do without them, meaning demand will change less relative to changes in the price.
2. Supply and demand isn’t the only driver of fluctuations in stock prices.
3. The technical trader may use stock charts of the analyzed trends and data to forecast the direction of prices and make trading decisions based upon the forecast.
4. By monitoring these levels closely alongside changes in volume activity, you can spot potential opportunities for profitable trades.

Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Supply & Demand trading revolves around the core principle that price movements in a market are driven by imbalances between buyers (demand) and sellers (supply). When demand exceeds supply, prices tend to rise, and when supply overshadows demand, prices typically fall. In trading, recognizing areas where these imbalances occur (Supply & Demand zones) can provide opportunities for entry and exit points.

Rally-Base-Rally (RBR) and Drop-Base-Drop (DBD) Zones

The equilibrium price of stock shares in Intel Corporation is initially $25, determined by the intersection of demand and supply curves D1 and S1, at which Q1 million shares are traded each day. A fundamental factor includes a company's earnings and its underlying financial strength, which investors may measure by analyzing the company's financial statements. By using fundamental analysis, an investor may determine if a stock is undervalued, and buy shares, or if a stock is overvalued, and sell shares.

So, let’s say investors are clamoring to buy shares of ABCD Inc., a hypothetical energy company. A day later, a Wall Street analyst publishes an optimistic report about the future of the energy sector. kvb forex This positive outlook triggers more demand for ABCD stock, pushing the price up to $40 a share. In general, strong earnings generally result in the stock price moving up (and vice versa).

How to use supply and demand in the stock market

Suppose Intel announces a new generation of computer chips that will lead to faster computers with larger memories. Current owners of Intel stock would adjust upward their estimates of what the value of a share of Intel stock should be. At the old equilibrium price of $25 fewer owners of Intel stock would be willing to sell. Since this would be true at every possible share price, the supply curve for Intel stock would shift to the left, as shown in Figure 4.5 "A Change in Expectations Affects the Price of Corporate Stock". In Figure 4.5 "A Change in Expectations Affects the Price of Corporate Stock", we see the supply curve shifting to the left, from S1 to S2, while the demand curve shifts to the right, from D1 to D2.

Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies. A riskier stock earns a higher discount rate, which, in turn, earns a lower multiple. Higher inflation is fx choice regulated earns a higher discount rate, which earns a lower multiple (meaning the future earnings are going to be worth less in inflationary environments). The way earnings power is measured may also depend on the type of company being analyzed. Real estate investment trusts (REITs), for example, use a special measure of earnings power called funds from operations (FFO).

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Those perceptions, whether or not they are true, can cause investors to buy or sell a particular stock, creating a supply and demand imbalance, which in turn drives the market price of a stock up or down. You can easily see supply and demand zones on your chart if you know what to look for. We will discuss some examples here to show you how to find and use them in your trading. In the H4 chart below, you can see the demand zone labeled DBR (drop-base-rally).

With a float of 1.48 billion shares, Home Depot (HD) requires much more money to move in price than Lumber Liquidators (LL), whose float is 25 million shares. If all factors are equal, investors should buy the stock with the smaller number of shares outstanding. The law of supply and demand reflect two central economic principles that describe the relationship between price, supply, and demand.