What is supply and demand in forex?
Supply and demand are the main drivers behind price changes in forex. High demand for a currency means there are more buyers than sellers, and this will cause a price rise. Likewise, supply exceeding demand means that currency will weaken.
When supply and demand for a currency are equal, or nearly so, the currency will range (become volatile in small increments or remain at its current level). By analyzing supply and demand, we can attempt to make predictions about where the price of a currency may go next.
In this blog, we take a look at everything you need to know about supply and demand - for beginners and for experienced traders to brush up their knowledge.
"Take your financial future into your own hands." - read our Q&A with trading expert and psychology coach Mandi Rafsendjani here>>
What’s the benefit of looking at supply and demand in forex?
There are many benefits to looking at supply and demand in forex. Supply and demand forex indicators are the perfect tools for traders who want to participate in sideways markets.
- It's been proven to be the most effective approach for identifying support and resistance levels, placing entry, stopping, and taking profit orders.
- Simplicity is the best thing about this system and the fact that it does not require any indicators to function.
- Another benefit is that trading decisions are based only on price action, some charts may even suggest the trading decision to you, you will just have to act on these signals.
How do I use supply and demand in forex?
It may seem odd, but you can describe the supply and demand relationship with respect to a product itself—in forex trading. Many traders are willing to buy lucrative forex pairs at "offer" price levels when they believe that the currency pair is undervalued.
So, when you see more buyers than sellers in a currency pair, you should consider buying (selling) that currency pair, because it will likely move higher (lower).
Finding zones or levels that have repeated prices in an environment of relatively low volatility helps traders stay on the right side of the market. When these price levels are hit, we can use them to make statistically sound trades that increase our probability of winning.
What are supply and demand zones?
Supply and demand forex zones are used to identify possible reversal points, trend breakout opportunities or consolidation areas for traders.
The supply and demand zones work exactly like they do in any other marketplaces. Key points:
- Higher prices will bring more supply, and lower prices will bring more demand.
- Think of the supply zone as an area where it will be hard to sell the currency pair and the demand zone as the opposite of that, where it will be hard to buy the pair.
In a nutshell, supply and demand forex zones are price levels at which supply and demand forces become balanced. They represent areas where there are many orders for a given currency pair in one direction or the other.
As these trading zones are constricted areas where the supply and demand levels meet, they become the locations of the highest relevance for price action. Understanding support and resistance levels above and below supply and demand forex zones can enable you to identify good risk/reward trade opportunities.
Many of the best businesses are built from scratch. Read our Q&A with entrepreneur Nick here>>
How do I identify supply and demand zones on price charts?
Identifying supply and demand forex zones can protect you from buying a stock on the upswing simply because of momentum. It may only be an upward breakout from a price range representing a lack of sufficient buyers or high enough demand to keep the shares at their previous level.
In a balanced supply and demand forex area, a stock may not see aggressive price movement because neither side has the advantage. Supply will meet or exceed demand at all times within this zone, and price rises are usually slow and steady. Some trades can expect sideways action with small trends in either direction.
When there is an imbalance between supply and demand, the supply/demand zone will change hands and be followed by the momentum that will create movement out of the range.
So - how can you identify supply and demand zones?
- In forex, a demand zone is a price level where demand from buyers exceeds supply from sellers. Also known as a “buy zone”, demand zones are generally used by traders to imply shift in buying interest.
- Applied to one-minute charts, these levels are marked using horizontal lines at the high and low of the last two to three candles.
- When we see examples where price action has travelled in a straight line, it gives us a high probability demand zone.
- The supply zone is where price has bottomed out. Here the sellers have exhausted their selling efforts, which is why the price has fallen into that particular zone.
- It is also referred to as a seller's market or a no-brainer area because at certain value levels. It's obvious to liquidate/sell one's position and take a point or x pips profit.
- Supply zones are often overlooked on price charts. Yet they can be very closely monitored for indications of future price moves.
- A supply zone is an area between a minimum of three bodies and a maximum of six candles, where the prices failed to move in a significant way in the opposite direction of the large candle.
How to Trade Supply and Demand Zones
Step 1: Entry Price
Stock traders often look at the extreme areas of support or resistance and immediately go long or short. It's almost like throwing darts at a board. It doesn't work often enough to give it a lot of merit. To make it effective, you want a well-defined price area that fits into your trading plan.
The Entry Point indicator uses a proprietary indicator algorithm to isolate and track price movement between demand and supply zones.
- When price breaks above a demand level, a buy entry is generated.
- When the price breaks below a supply level, a sell entry is generated.
Entry points are shown both on the charts and the order ticket.
By comparing the difference between the supply and demand levels, Entry Point can detect an imbalance in the market, making it a valuable tool for both price action traders and swing traders.
Price confirmation is required before an entry will be triggered, which prevents traders from chasing a market into a poor-quality region or failing to act when markets are moving quickly.
Still working on your trading plan? Here's the ultimate 8-step trading plan checklist>>
Step 2: Stop Loss
It's essential to know where the demand zone and supply zone end. Only when you do that can you have access to the whole market.
If you place your stop loss too close to the price and not far beyond the extreme ends of the demand and supply zones, you will only capture part of your possible profits.
The exact level of your stop-loss order should be determined based on personal preference. Many traders will place their stop loss just beyond the end of the zone, avoiding any false breakouts.
Other traders like to put their stop loss a bit further away from the zone in case there are false breakouts and a retracement back up into it. This would help them avoid getting stopped out, but it could also mean they miss some additional profit.
Not sure where to set your stop loss? Here's where - and why it's important>>
Step 3: Take-Profit
Understanding the basic set-up is relatively easy. As long as you can place your initial stop loss in the appropriate area, determining your first take-profit is relatively straightforward.
Once you have a better understanding of how to read support/resistance on your charts and have an idea of which levels are essential at different time-frames, placing profit targets becomes easier.
To escape the trade's losing constraints, you could close out your trade entirely and try again at a later time. Or you could place an exit stop-loss order to close part of the position.
Then, when you see demand or supply for your remaining position that meets your entry criteria, you could open a new trade that comes within the constraints of your remaining stop-loss. The outstanding feature about this approach is that it can be done automatically by using trailing stop-loss orders.