Stock Market: Why You Need To Know About Demand And Supply Zones?

Supply And Demand: The Reason Of Stock Price Movement In The Stock Market

Identifying and drawing SUPPLY & DEMAND ZONES is extremely essential to make stock market journey easier!


Stock-Market-Why-You-Need-To-Know-About-Demand-And-Supply-Zones

Ever wondered why and how the stock prices move? 


Even if you have not, this is the article that will explain to you how the prices go up and down in the stock market. 


For trade to take place in any field, there has to be a seller and a buyer. Otherwise trading is not happening.


In the same way, in order to move prices on a chart, there must be willing sellers and willing buyers.

 

When you sell a currency pair, let’s say EURUSD you are selling Euro to a buyer or buyers willing to buy Euro from you, and buying U.S. dollar from a seller or sellers willing to sell it to you.

 

If there are no sellers and no buyers in the market, the price won’t move and no transaction will take place. There are many players placing trades in the market, which make up the “order flow”.


These include retail traders, such as you and me, independent and private traders, institutions and professional traders.

 

Smart Money


The institutions and Hedge Fund Managers are very important because they have big money(often called Smart Money). Professional traders understand how Financial Markets work. They trade in the opposite way to the way in which retail traders do things. 


That explains why only 5% of retail traders make money in the forex or stock market. Because only 5% know how to trade like professional traders. 90% of the retail traders do not know how the Financial Markets work. And most importantly, they trade using new indicators and they end up operating in the opposite way in which professionals trade.

 

By learning how to trade the market using supply and demand, we will be able to enter the market at the same time as professionals and institutions do. We cannot know with certainty where they are placing their orders, but we can use supply and demand to locate high probability areas where a big chunk of order flows are still not filled.

 

NOTE: Not all the supply and demand zones yield a 100% guaranteed winning trades, that is why we use price action and other techniques to select high probability setups.


Demand Zone


We have already seen the candlestick formation and naming. LOWER SHADOWS of the candlestick represents the DEMAND or BUYING PRESSURE in the stock market.


Below is the example of demand zone:


Stock-Market-Why-You-Need-To-Know-About-Demand-And-Supply-Zones

Supply Zone


Similarly UPPER SHADOWS of the candlestick represents SUPPLY or SELLING PRESSURE in the stock market.


Below is the example of supply zone:


Stock-Market-Why-You-Need-To-Know-About-Demand-And-Supply-Zones


What if a supply or demand zone is created inside the trend?


In the situation described in above question, we have a drop-base-drop or rally-base-rally structures(CONTINUITY), and if they are formed at reversal points then we have a rally-base-drop or drop-base-rally structures(REVERSAL).


Let's see them one by one.


Drop-Base-Drop(DBD)


The drop-base-drop is a structure that forms a supply zone in the market, and that it is found only when the market is trending down. It is characterized by a drop in price, followed by a consolidation, and another dropdown. If the market returns to this structure it will make the price go down.


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Rally-Base-Rally(RBR)


The rally-base-rally is a structure that forms a demand zone in the market, and it is found only when the market is trending up. It is characterized by a rally in price, followed by a consolidation and another rally up. If the market returns to this structure, the price will go up.


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Rally-Base-Drop(RBD)


The rally-base-drop is a structure that forms a supply zone in the market. It is characterized by a rally in price, followed by a base or consolidation and then a strong drop in price. We only find this structure at reversal points. In other words, the rally-base-drop is only found when the trend reverses from going up to going down.

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Drop-Base-Rally(DBR)


The drop-base-rally is a structure that forms a demand zone in the market. It is characterized by a drop in price, followed by a base and then a strong rally in price. We only find this structure at reversal points where the trend is reversing from going down to going up.

Stock-Market-Why-You-Need-To-Know-About-Demand-And-Supply-Zones

Now we know how to identify the zones when the stock market is trending. This is the real value information that every stock market beginner, stock market trader and stock market investor must know.


We will now move further to see how we can draw the supply and demand zones on the price chart


How To Draw SUPPLY And DEMAND ZONES?


In order to locate a supply zone, we need to find a nice strong drop in price or a group of bearish candles. The chart below shows how the price left the base. The price has rallied up, paused for a little time forming a consolidation structure (base), then the price dropped from the base with very long bearish candles. This is a supply zone with a rally-base-drop type of structure.


SUPPLY ZONE drawing rules and example below:


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As we know, we have two types of supply structures: rally-base-drop (RBD) and drop-base-drop (DBD).

 

  1. Once we identify these structures on a chart, the next step is to look at the base structure.


  1. The structure of the base is important for us to successfully draw a supply zone.

 

  1. The price has to spend as little time as possible in the base to be considered as a high probability setup.

 

  1. A base with a range of one to six candles is considered an excellent base structure.


  1. To draw the supply zone, we first identify the structure (RBD or DBD), then locate the base and draw two horizontal lines, one at the top of the basing candles including the tails (wicks), and the other line at the bottom of the basing candles including only the candles’ body



DEMAND ZONE drawing rules and example below:


In order to locate a demand zone, we need to find a nice rally in price or a group of bullish candles. The chart below shows how the price has dropped down, paused for a little time forming a consolidation structure (base), then the price rallied up from the base with very long bullish candles creating a demand zone.


Stock-Market-Why-You-Need-To-Know-About-Demand-And-Supply-Zones

  1. Once we identify the demand zone on a chart, we also look at the base structure.


  1. A base with less than six candles is considered an excellent base to use.


  1. To draw the demand zone, we draw two horizontal lines, one line at the top of the basing candles including only the candles’ body, and the other line at the bottom of the basing candles including the tails (wicks).


NOTE: Demand & Supply Zones can be created new.


Guys, this is the real hidden truth in the stock market. This is how the analysts tell you the price target of a particular stock. This is one of the real and less known ways that you can say why the stock will reach or revert from a specific price level. 


One more worth the value observation is, in both of the above diagrams(DEMAND ZONE ON DBR STRUCTURE & SUPPLY ZONE ON RBD STRUCTURE), you can see the price retested the demand & supply zones. This indicates buyers tried to break the supply zone and failed due to selling pressure & due to the already placed sell orders present at that price level. Reverse is true for sellers.


Book Alert


Rich Dad's Cashflow Quadrant: Guide to Financial Freedom

BY ROBERT T. KIYOSAKI 


KEY TAKEAWAYS

  • Supply and Demand is the reason to move prices on the charts.
  • Identifying supply and demand zones is beneficial in the stock market.
  • Drawing supply and demand zones is critical for profit making trades.
  • Supply and demand zones work as support and resistance in the stock market.
  • Rally-Base-Rally and Drop-Base-Drop structures are continuation of trend.
  • Rally-Base-Drop and Drop-Base-Rally structures are reversal of trend.
  • Volume activity will be crucial while price retesting the zones and breaking the zones.

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