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The supply and demand zone trading strategy is a powerful approach in the world of trading, focusing on identifying key areas where the forces of supply and demand interact. This strategy relies on recognising zones on price charts where buying and selling activities are concentrated, providing valuable insights for traders. By understanding these zones, market participants can make informed decisions to capitalise on potential price movements and enhance their overall trading success. In this guide, we find out more.
Table of Contents
Defining Supply and Demand Zone
Supply Zone
A price range where merchants often sell is known as a supply zone. The area with the largest sales potential is above the current price. Unfulfilled sell orders are normally filled when the market reaches a known supply price level, which often drives the price lower.
Demand Zone
A price level where traders often buy is known as a demand zone. This region is represented below the current price, where the possibility of or interest in purchasing is greatest. Several buyers are often available with purchase orders in a known demand zone at that level.
Differences Between Supply and Demand Zone
Understanding the distinctions between supply and demand zones is essential for traders utilising these concepts in their technical analysis and decision-making processes. Here’s a tabulated comparison between the two:
| Aspect | Supply Zone | Demand Zone |
| Definition | Area where selling interest surpasses buying interest. | Area where buying interest surpasses selling interest. |
| Appearance on a Chart | Often seen as a resistance area, where price tends to reverse downwards. | Typically identified as a support area, where price tends to reverse upwards. |
| Price Action | Prices usually decline after reaching a supply zone. | Prices tend to rise after reaching a demand zone. |
| Role in Trend Analysis | Considered as potential areas to short or exit long positions. | Viewed as potential areas to buy or exit short positions. |
| Indicator for Traders | Traders may look to short trades when price approaches a supply zone. | Traders may consider long trades when price approaches a demand zone. |
| Market Psychology | Indicates an excess of sellers over buyers in a specific price range. | Indicates an excess of buyers over sellers in a specific price range. |
| Relevance in Trading | Important for trend continuation and reversal strategies. | Crucial for identifying potential reversal points and trend continuation. |
Identifying Supply and Demand Zones
The initial step in identifying supply and demand zones involves recognising market imbalances, where substantial price shifts result from imbalances in supply and demand. These imbalances typically lead to significant upward or downward price changes. On a chart, traders focus on recognising larger candles known as extended range candles (ERCs) or exploding price candles. Thereafter, the next three crucial steps in discovering supply and demand zones follow.
Step 1: Determine the Pricing Now
To begin the supply and demand zone identification process, traders need to first locate the current price on a given chart. Following this, they should identify a substantial, cohesive cluster of candles on the left side of this chart, indicating either upward or downward movement. Demand zones typically showcase notable prior downward price movements, while supply zones demonstrate the robust preceding upward price
Step 2: Look for ERCs
In the next step, traders should search for ERCs. These candles are characterised by their substantial bodies and minimal to nonexistent wicks. It’s important to note that a candle is not typically considered an ERC if the size of the wicks and body is the same.
Step 3: Determine Origin of Price Movement
In the final step, traders need to identify the source of the price change on the chart. If the price rose with small-sized candles, paused, and then fell, as indicated by numerous ERCs, this starting point becomes the foundation of the supply zone.
Laws of Supply and Demand Trading
The dynamics of supply and demand are influenced by various external factors and do not operate in isolation. Nevertheless, the four fundamental concepts that illustrate the correlation between demand and supply offer a straightforward explanation of their relationship.
- Supply remains unchanged while demand rises: In a market characterized by price competition, this scenario leads to a price increase. The scarcity of the product elevates its value.
- Supply remains unchanged while demand declines: A persistent decrease in demand results in an oversupply of the product, leading to a reduction in its value.
- Supply rises while demand remains steady: When a product becomes widely available, its price tends to drop. This situation may lead to an overstock condition if demand remains constant for an extended period.
- Supply declines while demand stays steady: The price will increase when the supply of a product decreases without a corresponding change in demand.
Demand and Supply Vis-a-vis Support and Resistance
- Support and resistance levels on charts are typically represented by historical price points, whereas the identification of demand-supply zones occurs after analysing current price movements.
- While a line is sometimes employed to delineate support and resistance, the demand and supply zone is conceptualised as a chart region.
- The strength of support and resistance develops through testing and adherence over an extended period, but this strength weakens when subjected to such tests. If broken, support transforms into resistance, and resistance can revert to support. However, once destroyed or absorbed, the demand and supply zone ceases to exist.
- Utilising the demand and supply zone in a trading strategy proves advantageous as it considers the most recent price points.
Conclusion
If a trader aims to predict price movements and identify recently formed trading opportunities, leveraging supply and demand zones can be advantageous. Utilising the supply-demand indicator facilitates a quick and straightforward identification of all supply and demand zones. This enables the creation of an effective supply and demand trading strategy, enhancing the ability to trade efficiently and achieve desired targets. Traders participating in online share trading through platforms like Share India can benefit from powerful tools and indicators, such as supply and demand zones, to strengthen their trading strategies and make more informed decisions, ultimately increasing the efficiency of reaching their trading objectives.