Supply and Demand

What is Supply and Demand trading?

Goods are bought and sold at what their perceived value is at the time. The same applies for financial instruments, with the expectation that their price will change in the future and will be bought or sold at differing prices, potentially bringing a profit for traders.

Prices adjust according to willing buyers and sellers, in-turn creating supply and demand zones, the sellers represent the amount that is available for sale (supply) while buyers represent the amount available to be bought (demand). It is when there is an imbalance between buyers and sellers that we see a change in price, for example, when there are more willing sellers, price will begin to fall until it finds more buyers and when there are more willing buyers, price will rise until it finds more sellers. Knowing where these areas are on a price chart will give you an edge, and allow you to follow the interests of big/smart money, the real market movers.

Identifying Supply/Demand zones

First we look at the chart for an area where price strongly shot up from (demand) or dropped away from (supply).

The next step is to mark the base of these moves.

We always mark the outermost limit of a move, marking the inner is a personal preference for each of us depending how loose or tight one wants to keep their zones.

RBD DBR and RBR DBD

As price moves it creates (swing) highs and lows, the extremes of these moves can be marked as “bases”, just like the ones marked above. When bases are created after a “rally” or a “drop” they form a Rally-Base-Drop (RBD) or a Drop-Base-Rally (DBR).

Let’s mark some on a chart.

Price can also create small bases along a rally or a drop, these smaller moves are known as Drop-Base-Drops (DBD) and Rally-Base-Rallies (RBR).

Let’s find some on a chart.

Balance vs. Imbalance

During the formation of a base, we consider price to be in balance. This is because there is not a significant difference in the amount of buy or sell orders in this area thus price doesn’t rally or drop as long as this balance exists. For price to start moving in a direction there needs to be more of one type of order (buys or sells) than the other causing price to rally or to drop, it is at this point a base is confirmed and a decision that price was either too cheap or too expensive has been made. When price moves away from a base there are naturally unfilled orders which remain, so when price returns to the base in the future we can expect the remaining orders to be triggered causing a reaction in price. It is this what supply/demand traders try and take advantage of.

When Supply/Demand breaks

After a level is tested many times or during a strong move, Supply and Demand levels eventually break. This can be due to the once remaining orders being triggered and gradually removed, or an overwhelming amount of orders in the opposite direction breaking the level. Orders can even be removed manually by a trader who formed the level.

Every broken supply/demand level holds some significance. Where once were more sell orders (supply) now more buy orders remain/exist, with the opposite applying for demand levels. This means upon return to a broken level, we could see a reaction in price, these levels are often referred to as “swap” levels.

It is at these levels where we can look for conformation to take a trade. This is how the look on a chart:

Part 2: Supply and Demand as reactions to the FTR

Wouldn’t it be nice if we were able to trade supply/demand levels knowing when one will hold or when one will break? Well believe it or not we can, because as hard as it may sound supply/demand levels are NOT created equally! There are some that are much more important than others, and some even further beyond important. Most articles on supply/demand will mostly have you read about “reactions” to levels, because that is what is important right? Sure, they are important if all you want to do is look at the far right of your charts and gamble, but what are the supply/demand levels themselves reactions to

Hopefully we have pricked your attention, because this is going to be the first time something as important as this will be covered in a supply/demand article and it is very exciting to be writing about. I can already hear you all screaming; hold on! Supply/demand levels can be reactions to other supply/demand levels! Or Support/Resistance levels! Or MA’s and fibs! Please…If you are still using MA’s and fibs, let me direct you to our technical analysis article.

The truth is; supply/demand are often reactions to the Flag Limit (a RBD or DBR after a break of a high or low). You can read about the FL here. It is these levels that are the important ones, the ones that will contain price in a range, and give you the heads up when price is going to change direction. Sure there are other areas and reasons supply/demand forms, just like the ones you yelled at me earlier, but these are lesser important levels, ones that are much more subjected to breaks and fake moves! 

Knowing the important ones will keep you on the right side of the market at all times.

Here is some help on defining these levels, but remember, to truly understand them you need to find and mark them out for yourselves!

There are plenty of other supply/demand levels which I did not mark, but they would all hold lesser importance than the ones formed after the breaks of highs or low. However, important levels can also break so it is important to monitor these levels for signs of reversals. When they break however, they hold a lot of importance.

You can see from the image above I marked a DBR after a break of the highs to the left of it. This is a level that forms after a break of a high, it’s a FTR, and we can expect it to bounce price, but it doesn’t, it breaks. The FTR that proceeds is the RBD that is the important one, this is where we want to keenly look for PA.

How to trade Supply and Demand Areas

Conventional supply and demand trading teaches the game of probabilities; by trading enough zones, with a decent enough RR, one should make money. These levels are in general blindly traded with a stop just above, and a target at the next level, this is very often done with limit orders, longing there is a decent enough RR (2:1 is usually good enough).

If a proper plan is in place, this method will make you money, but it is still essentially gambling, and here at RTM we don’t gamble. We want to be absolutely sure a level is going to hold, and once we know, we want the very best RR on every trade we take (yes 15:1 can be more common than you think!). By looking for PA in the correct spots, there is no reason you shouldn’t be able to get into great trades, with great rewards and very little risk. You can find everything you need to know about PAin the markepediasection. So get to work, log your progress in the homework section and join our great community.

By Harry & Pedini

PRICE READING

Price Action

Past

·  Supply and Demand

·  Support and Resistance

·  PAZ - Price Action Zones

·  Caps on Price - RBD/DBR *

·  Flag Limits - DBD/RBR *

·  Fail to Return - FTR

Approach

·  Compression *

·  3 Drive

·  Momentum In

·  Stacked Orders/Zones

·  Fakeouts 

Reaction

·  Engulf

·  Quasimodo *

·  Diamond *

·  The CanCan *

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