Why Supply and Demand?

Sam Evans

In my nine years of studying the markets and actively trading, I have been introduced to and come across various techniques on how to enter and exit positions in the FX markets. Some of the stock trading strategies were complicated, others were far more technical and relied on a variety of different indicators to get the correct signal when to buy or sell. However, over time I realized the most important thing a trader needs to accomplish in his or her day-to-day routine, is the ability to be able to recognize an opportunity and take it when they see it. The longer it takes, the more signals you require, and the more emotional you can get, the harder this simple action becomes. I like many others, realized that I needed to keep things as simple as possible and allow myself to recognize an objective trading opportunity when I saw it and execute my plan without emotion.

So this brings us to the question: why use supply and demand zones? Having worked with and taught thousands of students around the world, I have noticed that the majority of the time they expect me to show them complicated charts and various squiggly lines and patterns drawn across the price bars to help me make a trade. Let’s face it, if you pick up the average book about technical analysis which you can find on Amazon, most of them will have those squiggly lines and complicated chart patterns, so that’s what people are used to! When I show people that really all it takes is nothing more than a simple candlestick chart to be able to recognize a trading opportunity in the markets, they raise an eyebrow in question, or a big smile appears on their face when finally they realize that there is something simpler out there.

In a previous article some months ago, I wrote about one of my heroes Albert Einstein and how one of his most famous quotes stated that the most complex questions in life always have the most simple answers. In the context of trading I believe that there couldn’t be a more true statement. In the reality of how stock markets work, we never really know what’s going to happen next. This is a fact that everybody needs to accept right from the start of their trading. We can take a strategy and use as many different inputs as we like to try to help us to gauge direction in the market, however no set of tools will ever give us a guarantee of success. Yet, people still search for the Holy Grail. Trying another indicator or looking for the next wonderful chart pattern, all of which inevitably end up in further frustration and emotional peaks and troughs for the trader. You never want to find yourself in a position where you keep adding on layer and layer of complexity to your charts.

The more and more information you use to try to find a trading opportunity, the less likely that you are going to be focusing on the one true thing that will always give you the clearest idea of price action, mainly price itself. By focusing on the ancient laws of supply and demand, our students respect price and price alone and the dynamics which dictate the movement of price in any free-flowing market. At the end of the day, if I’m going to make a decision whether or not to buy or sell a currency pair, I want to make a decision based upon the hard evidence that is clearly in front of me. Price is the only thing that will give me that information. What is glaringly obvious when you start to incorporate an understanding of supply and demand onto a price chart, is that you can actually see when major activities of buying and selling have taken place on the charts and if you look at this the right way, you can also understand what this means for upcoming trades as well. Would it not make sense to buy in an area where demand has shown itself to be greater than supply? Would it also not make sense to be selling at an area where supply has shown itself to be greater than demand? The rules clearly state that if demand is greater than supply prices must go up and if supply is greater than demand prices must go down. Our task as objective and disciplined traders, is to simply incorporate this dynamic into our trading activity.

Let’s take a look at an example and see what it shows us:

sevans 20130910 - euro-vs-dollar

In this basic example on a daily chart of the Euro versus the US dollar I have highlighted a major area of supply and a major area demand on the chart. From this example we know for a fact that there were more willing sellers than buyers in the upper supply area and there were a greater number of willing buyers than sellers in the lower demand area. Knowing these two vital facts which are objective and purely based upon price, what the chart is telling us, is that we should know when prices are at supply we should look to sell and when prices are at demand we should look to buy. People will never make money consistently if they buy after everybody else has bought and will struggle on the short side if they sell after the majority has already sold. By recognizing this simple piece of logic, we can use demand and supply to maximize our gains when we are right and minimize the losses to the smallest level when we are wrong. When our students buy at demand zones and sell at supply zones, they have the greatest possible reward and the smallest possible risk, thus having  a huge edge when they speculate in the marketplace.

Trading is a competition which involves a transfer of money from the accounts of those who don’t know what they’re doing into the accounts of those who do. Most people like to make trading complicated and rely on tools to make the decisions for them like the example below:

sevans 20130910 - moving-averages

In this example, I’ve applied two simple 20 and 50 period moving averages. We need to remember if we are going to incorporate technical analysis tools and indicators into our trading, every single signal that we get will always be based on price. This means that price has to move before it can send a signal to the indicator to tell me what to do. I don’t want a lagging indicator when I’m trading because I’m always looking for the best risk to reward ratio and I need to focus on price to give me the lowest risk trading opportunities at any time. This is where price and demand will always give you an earlier signal in advance, something that a technical indicator cannot possibly do. Can you see how in this example, the fast moving average crosses the slow moving average giving us multiple buy and sell signals? While a few of these are correct signals, they incorporate very large risks are very low reward and many of those signals come much later, after prices have already been going up or down. The signals are way too late and always punish the trader by decreasing the potential reward and increasing the overall risk. This is why looking to buy demand and sell at supply always gives the best odds of success. This is not a chicken and egg question. Price always comes before the indicator, not the other way round. If you remove price from a chart the indicator would not function. That is why I focus on price first and foremost.

This is a topic I could spend hours and hours writing about. In my own journey as a trader, having tried things from Moving Averages to Bollinger Bands, MACD and various oscillators, I found that the one thing which never let me down in the long term, is a solid understanding of how prices move and why they move in the manner they do so. In two weeks, I would like to follow up on this discussion about supply and demand, by talking about what is really happening at a deeper level and how institutions use this simple approach to the market, to maximize their own gains in their speculative activities.

Have a great week,

Sam Evans

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.