Supply and demand: The key mechanism behind asset price fluctuations and choosing the right trading timing

Many people may wonder why the prices of financial assets constantly fluctuate and why some traders can consistently profit. The answer lies in understanding supply and demand, which is the fundamental driving force behind price movements in all markets. Supply and demand are not just economic theories found in textbooks but practical tools that can be used to effectively predict market trends.

Basic Understanding: What Are Supply and Demand and How Do They Relate to Price?

What Is Demand?

Demand refers to the desire to buy goods or services at various price levels. When we plot this demand on a graph, we get the demand curve, which shows the relationship between price and quantity. Each point on this curve indicates the quantity that buyers are willing to purchase at a specific price.

The basic law of demand states that demand is inversely related to price—that is, as price increases → demand decreases; as price decreases → demand increases.

This relationship is driven by two main factors:

Income Effect: When prices fall, the amount of money you need to spend decreases, leaving you with more disposable income, which allows you to buy more.

Substitution Effect: When prices drop, the good becomes relatively cheaper compared to similar products, prompting consumers to switch and buy more of this cheaper alternative.

Other factors influencing demand include consumer income, personal preferences, the number of consumers in the market, future price expectations, seasonal factors, government policies, and consumer confidence.

What Is Supply?

Supply refers to the willingness of sellers to offer goods or services at various price levels. Plotting this on a graph yields the supply curve, which shows the quantity sellers are willing to supply at each price.

The law of supply states that supply is directly related to price—that is, as price increases → sellers are willing to supply more; as price decreases → they supply less.

Factors affecting supply include production costs, technological capabilities, the number of competitors, future price expectations, input prices, weather and natural disasters, tax policies, and access to financing.

Equilibrium: The Price That Sets Itself

Demand or supply alone cannot determine the actual market price. When demand and supply curves intersect, they form the equilibrium point, which is where the market price tends to stabilize.

Why does this happen?

• If the price is above equilibrium, sellers produce more, but buyers buy less → surplus occurs → prices are pushed down toward equilibrium.
• If the price is below equilibrium, buyers want more, but sellers supply less → shortage occurs → prices are pushed up toward equilibrium.

From Theory to Practice: Supply and Demand in Financial Markets

In stock and financial markets, supply and demand operate similarly, but the influencing factors are more complex.

Factors Driving Demand in Stock Markets

Macroeconomic Factors: Economic growth, inflation rates, and interest rates directly influence investment decisions. For example, low-interest rates make stocks more attractive as alternative investments.

Market Liquidity: More money circulating in the system provides investors with more capital to invest.

Investor Confidence: News, earnings forecasts, political events—all impact buying decisions.

Factors Driving Supply in Stock Markets

Corporate Policies: Decisions like issuing new shares, buybacks, or dividend payments affect the number of shares available.

Initial Public Offerings (IPOs): New companies entering the market increase the supply of securities.

Regulations and Rules: Conditions such as the Silent Period, which restricts major shareholders from selling, influence supply.

Demand and Supply Zones: Using Supply and Demand to Make Profits

Demand Supply Zone is a concept used to identify trading opportunities when prices are temporarily out of equilibrium. During these zones, prices tend to move rapidly, often forming large candles (green for upward moves, red for downward moves).

Understanding Candlesticks

Green Candlestick: Close > Open → Buying pressure dominates → Price likely to rise.

Red Candlestick: Close < Open → Selling pressure dominates → Price likely to fall.

Doji: Open ≈ Close → Balance between buyers and sellers → Direction is uncertain.

Analyzing Price Trends

Uptrend: Making higher highs → Strong demand.

Downtrend: Making lower lows → Strong supply.

Sideways: Moving within a range → Equal demand and supply.

Support and Resistance

Support: Price level where demand is expected to be strong enough to prevent further decline. Price rarely falls below this level.

Resistance: Price level where supply is expected to be strong enough to prevent further rise. Price rarely exceeds this level.

Practical Trading: Entry and Exit Signals from Supply and Demand Zones

In real trading, two common approaches are used:

1. Reversal Trading

Demand Zone Drop Base Rally (DBR): Excess supply causes price to drop → consolidation (base) forms → new buying interest emerges → price reverses upward (rally). Traders buy on breakout above the consolidation and set stop-loss at the lowest point of the base.

Supply Zone Rally Base Drop (RBD): Excess demand causes price to rally → consolidation (base) forms → new selling interest emerges → price reverses downward (drop). Traders sell on breakout below the base and set stop-loss at the highest point of the base.

2. Trend Continuation Trading

Rally Base Rally (RBR): Price rises → consolidates → positive factors persist → price continues upward. Traders buy on breakout above the consolidation.

Drop Base Drop (DBD): Price declines → consolidates → negative factors persist → price continues downward. Traders sell on breakdown below the consolidation.

To maximize effectiveness, accurately identify the zones and wait for price testing these levels before entering trades, with proper risk management and stop-loss placement.

Summary: Understanding Supply and Demand = Reading the Market’s Heart

Supply and demand are not just distant economic theories but essential principles explaining why prices move the way they do. Mastering these concepts is like wearing special glasses that allow you to see the market more clearly.

Applying supply and demand principles in trading requires experience and practice. Analyzing real-time price action helps develop a clearer picture, enabling more informed investment decisions. Remember, knowledge alone is not enough—practical experience is where true skills are developed.