Trading with Supply and Demand Zones

by | Jul 5, 2022

Supply and demand zones

What are Supply and Demand Zones?

Supply and demand zones are a great way to spot entries and possible areas of rejection when using technical analysis for trading. Let’s dig a bit deeper as to why and what they represent. 

Technical Analysis and Price Action are ways of looking at charts to present a glimpse into market sentiment. You’ll often hear people question its validity by saying things such as ‘they’re just random lines drawn on a chart’ or ‘its just luck, you guess where things will happen and if they do great, if not, you just were unlucky’. 

Let’s look into what these lines and candles represent. Candles represent the range of price movement within a given time frame. They show the market’s open, high, low, and close price for your particular time frame in a neat and organized way, but they do much more than most think. 

Price, in any market, is dictated by the fundamental principles of supply and demand. A good or asset is only worth what someone is willing to pay for it. If the price is out of their perceived value zone, they will sell it. Here is a real world example.

Marsha buys a Tesla for $50k hoping that the electric transmission will provide the savings in gas expenditures she is looking for. At $50k she thinks the vehicle’s benefits are a great value, especially with gas prices rising and currently at $7/gallon.

If the price of gas falls to $2.50 (which would be a blessing for us all), and the cost of electricity rises, she might change her bias and start to reconsider her purchase. She might eventually decide that the savings she expected don’t quite match up with her goals, and she might decide to sell her Tesla for the best price she can get. 

You might be thinking what does this have to do with trading? Well the candles represent buyers and sellers fighting to find a fair price for an asset at any given time. There are certain prices that buyers feel comfortable buying, and there are certain levels that sellers feel comfortable selling. 

By examining the chart you can identify where these price levels lie, and use them to your advantage to enter a short (Sell) position, or long (Buy) position. 

Think of it this way, when you look at a chart, there are many other people looking at the same chart as you thinking the same thing as you, therefore these ‘imaginary’ levels turn true over any given period of time, sort of a life a self-fulfilling prophecy.

More About Supply and Demand Zones

There is an underlying order in the markets at all times. This order is created by the continuous flow of buy and sell orders from market participants. The interplay between these orders creates what are called supply and demand zones.

Supply and demand zones are simply areas on a price chart where the market has seen a significant amount of buying or selling activity. These zones are important because they represent areas where the market has been unable to move prices lower (for demand zones) or higher (for supply zones).

Chart Below:

Supply is the area where price visited but was unable to break due to sell pressure, or in laymen’s terms, there were more sellers than buyers at the price which caused the price to reject and go down.

Demand is the area where the price found support, meaning there were buyers waiting to purchase at what they believed were prices of value. There were more buyers than sellers at this level, causing the price to go up.

Once a supply or demand zone has been identified, traders can then look for trading opportunities in the direction of the underlying trend. These trades can be entered using a variety of different methods, such as limit orders or market orders.

To be successful in trading with supply and demand zones, traders need to be able to identify these zones on a price chart. This can be a difficult task, as there are no set rules for how to identify them. However, with practice and experience, it is something that any trader can learn to do.

When trading with supply and demand zones, it is important to remember that they are not exact levels. Rather, they are areas where the market has shown a willingness to buy or sell at certain levels. As such, there may be some false breakouts of these levels.

It is also important to remember that just because a zone has been created, it does not mean that the market will automatically move in that direction. Rather, traders need to wait for confirmation before taking any trades.

By using supply and demand zones, traders can get a better understanding of the underlying order in the markets and take advantage of opportunities that they may otherwise miss. With practice and experience, any trader can learn to identify these zones and use them to their advantage.

How to Identify Supply Zones

If you’re looking at a chart and trying to identify potential supply zones, there are a few things you can look for. First, you’ll want to look for areas where the price has previously struggled to move higher. This could be an area where there was significant selling pressure and the price was unable to break through.

Another thing to look for is an area where there is a lot of overhead resistance. This is an area where the price has repeatedly tested and failed to break through. These are typically areas where there is a lot of supply (sellers) and not much demand (buyers).

Once you’ve identified potential supply zones, you can then watch for price action around these areas. If the price starts to struggle as it approaches a supply zone, that’s a good sign that there is supply in the market. Similarly, if the price starts to stall or reverse when it hits a supply zone, that’s also a good indication of supply.

Of course, no trading strategy is perfect and there is no guarantee that the price will always react in the same way around supply zones. However, by watching for these signs, you can get a better idea of where potential supply might be lurking in the market.

How to Identify Demand Zones 

To identify demand zones in charts, look for areas where the price has risen sharply and then stalled or reversed. These are typically areas where there is a lot of buying interest, as reflected by the large number of orders placed at that level. Demand zones are often marked by a cluster of candlesticks with small wicks, indicating that buyers are willing to pay up for shares even at higher prices. Look for these patterns in order to identify potential demand zones in your charting.

A demand zone is a price area where there is strong buying interest. This is most likely caused by a large number of buying orders at that level. When price reaches the demand zone, some orders get executed and the rest get absorbed. What you will see on the chart is a sharp move to the upside as orders get filled.

There are four main types of supply and demand patterns:

1. Reversals

2. Continuations

3. Exhaustions

4. Failed Reversals

1. Reversals: A reversal pattern occurs when the price action reverses from an uptrend to a downtrend (or vice versa). This indicates that there has been a shift in market sentiment and that the previous trend is no longer in effect. There are two main types of reversal patterns: head and shoulders and double top/bottom.

2. Continuations: A continuation pattern occurs when the price action continues in the same direction as the previous trend. This indicates that the current trend is still in effect and is likely to continue. There are two main types of continuation patterns: flag and pennant.

3. Exhaustions: An exhaustion pattern occurs when the price action reverses from an uptrend to a downtrend (or vice versa) after reaching a certain level. This indicates that the market is overbought or oversold and that a reversal is likely to occur. There are two main types of exhaustion patterns: bearish and bullish divergences.

4. Failed Reversals: A failed reversal pattern occurs when the price action reverses from an uptrend to a downtrend (or vice versa) but then fails to continue in that direction. This indicates that the market is not yet ready to reverse and that the current trend is still in effect. There are two main types of failed reversal patterns: bullish and bearish divergences.

Supply and Demand Chart Patterns

When you see a supply or demand pattern, it’s important to wait for confirmation before taking any action. This means waiting for the price to close outside of the pattern before entering into a trade.

Best Supply and Demand Zones Indicators

There is no one “best” supply and demand zone indicator. However, there are a few indicators that can be used to help identify these areas on a price chart. Some of the most popular indicators include the following:

1. Fibonacci Retracement Levels: These levels show where the market is likely to find support or resistance after a move higher or lower.

2. Pivot Points: These levels show where the market is likely to turn after a period of consolidation.

3. Support and Resistance Levels: These levels show where the market has previously found support or resistance and are likely to do so again in the future.

4. Trendlines: These lines show the overall direction of the market

We will cover the above indicators in detail in later posts.

The supply and demand zones we’ve covered in this article are important tools to help you understand market sentiment. Remember that they are not guaranteed to hold true in every case, but they provide a very good estimation of where to buy and sell. Additionally, there are many technical indicators you can use on your charts that may make spotting them a bit easier. We hope you feel like you have a better grasp on the topic now and are excited to apply what you’ve learned to improve your trading skills. Thank you for following along!