Supply & Demand Theory, also known as the “Auction Market Theory”, is the driving force behind price action fluctuations in the markets. Supply & Demand trading aims to identify where there is an imbalance in order flow between buyers and sellers. Below you’ll find 3 things to watch when trading using this methodology.
#1. Get in the Zone
Are you in a supply zone or a demand zone? If supply is greater than demand, prices will decrease because there are more sellers than buyers. If demand is great, you’ll see prices on the rise. In a supply zone, prices will be above the current bid price, hitting at the ask and in a demand zone they will be lower or hitting at the bid. Identifying who is in control will put you on the path towards greater trade success.
#2. Identify the Pattern
Reversal or Continuation? The next step is to identify where the pattern is headed. If you’re seeing a trend reverse or continue, you’ll know whether to buy or sell depending on which zone is most active, Demand or Supply. In a supply zone, you will likely have a bias to sell short since supply is high and price can reverse at this area by falling to lower levels. If you are in a demand zone, you will have a bias toward a long position since demand is high and price will likely rally. Knowing your plan and strategy ahead of time will make this easier.
#3. Rally or Drop?
Is your overall price going up or down? Identifying patterns of when a price “rallies” or rises and when a price is dropping will also help determine which zone and pattern you’re seeing in action. There are commonly 4 patterns you’ll see:
- Rally/Base/Rally
- Rally/Base/Drop
- Drop/Base/Drop
- Drop/Base/Rally
If you’re headed towards a Rally pattern, you’ll want to buy low and sell high. If you’re headed towards a Drop pattern, you’ll want to sell short to gain a profit.
Identifying patterns, whether with or without technical analysis tools, will help you on the path towards successful trading. This along with a solid strategy will help combat the trading jitters and keep you from letting emotions steer you away from a profitable future.
