The law of supply and demand is a prominent factor that controls price changes across different marketplaces. As much as understanding technical analysis is critical to trading the foreign exchange market, it is also nice to watch out for supply and demand zones.
Banks and large financial institutions work with these zones in the hope of executing future orders. As a trader, you need to keep an eye out for certain price trends to maximize how supply and demand work.
This guide will walk you through supply and demand zones, the major types, and how to identify them with chart trends.
Supply and demand zones
A supply zone is an area on the price chart where traders sell. This area is always above the present price, and they have the highest selling potential or interest.
When market prices reach the supply zone, many pending orders get executed, and the price crumbles. The chart below gives a graphic explanation of what supply zones are.
The chart above shows market prices reaching a specific supply zone, waiting for some time, and declining. This trend will continue until all awaiting orders are executed.
On the other hand, a demand zone is an area on the price chart where traders place buy orders. This zone is always below the present price, showing a high buying potential or interest. This implies that buyers have orders waiting to be completed by the price trigger. Refer to the chart below to see what a demand zone looks like.
The chart above shows an instant move upward.
Types of supply and demand trends
There are two main types of supply and demand trends or patterns you should look out for.
When the price chart shows a reverse movement, a reversal trend appears on the chart. This price movement can either be from down-upwards or up-downwards. There are two examples of the reversal trends:
Drop-base-rally: In the drop-base-rally, the market price drops (moves downward), retains that momentum for a while, and eventually rallies high.
Rally-base-drop: After the price rallies high, it remains there to create a base, the eventually falls due to huge supply orders being executed.
Continuation trends can be seen on the chart when the price pattern keeps moving in one direction (upward or downward). These trend types are considered weak as there could be a breakout anytime. Let’s examine the two types of continuation trends.
Drop-base-drop: This trend shows a price drop, a pause to create a base, then a further price drop.
Rally-base-rally: The trend shows an upward price movement, a short pause, and a stronger rally.
Easy ways to find supply and demand with trends
The easiest way to find supply and demand zones is to take note of imbalances in market prices. This refers to the significant change in prices tending towards a direction due to supply and demand.
The chart above shows different significant price changes, representing imbalances. Therefore, always check for significant price changes when finding supply and demand zones.
The steps below will help you understand better:
Step 1: Find the current price
Before doing anything, make sure you know where the current price is on the chart. After that, look leftward to identify a significant price change (positive or negative). As a quick refresher, supply zones show downward movement while demand zones show upward movement.
Step 2: Find extended range candles (ERCs)
After identifying significant price changes, it is time to find extended-range candles. These are candles with extended bodies, lacking wicks. Candles with equal body and wick size are not considered ERCs.
Step 3: Identify price movement origin
The last step is to identify the price movement origin. As the chart below shows, price movement origins are usually the base of every supply or demand zone.
As the uncertainties in the market keep increasing, you must know how to identify supply and demand zones. Not only do these factors affect changes in market prices, but they also help with your trading strategy. Other indicators that help you identify supply and demand zones are support and resistance levels, pivot points, and Fibonacci levels.
So, there you have it! Always remember to keep an eye out for the trends we have highlighted in this article and ensure to make it your go-to guide to trading.