Building profits from supply and demand: The key to effective stock trading

Retail traders often see only the price line moving upward on the screen, but behind the price movements are forces of two opposing sides engaged in endless battles. One side wants to buy (demand), and the other wants to sell (supply). A deep understanding of this mechanism opens new doors for price prediction and more accurate timing of trades.

The relationship between demand and supply is fundamental to economics that governs price setting in all markets. Whether for general goods or financial assets, this mechanism is also a powerful analytical tool for investors to forecast the direction of stocks and other assets.

What is (Demand): The desire to buy that drives prices

Demand represents the quantity of goods or services that consumers or investors are willing to buy at various prices. When analyzing this with a graph, you get the (Demand Curve), which shows the relationship between price and quantity.

Basic principle: The Law of Demand
Buyers will purchase more when prices are lower and less when prices are higher. This relationship is natural in markets, resulting in a downward-sloping demand curve.

Price changes affect demand through two channels:

Income Effect (Income Effect): When prices fall, consumers’ purchasing power increases, allowing them to buy more. Similar to a salary increase, even if prices stay the same.

Substitution Effect (Substitution Effect): When a product becomes cheaper, consumers tend to buy that instead of other relatively more expensive goods.

Other factors influencing demand:

• Consumers’ income and wealth
• Market tastes and preferences
• Number of potential buyers
• Expectations about future prices
• Prices of related goods (Substitutes or complements)

In financial markets, stock demand is also influenced by macroeconomic factors, investor confidence, and earnings forecasts.

What is (Supply): The power of sellers in the market

Conversely, supply indicates the quantity of goods or services that producers or sellers are willing to offer at various prices. The (Supply Curve) shows a positive relationship between price and quantity.

Basic principle: The Law of Supply
Sellers will offer more when prices are higher because profits increase. Conversely, they will reduce supply when prices are lower. This relationship makes the supply curve upward-sloping.

Factors determining supply:

• Production costs and raw materials
• Technology and production efficiency
• Number of producers in the market
• Overall business environment and tax policies
• Producers’ expectations about future prices
• Weather and natural disasters (especially for agricultural products)

In stock markets, supply is influenced by corporate decisions such as issuing new shares, buybacks, and exchange listing requirements.

Equilibrium: The point where prices find a “home” temporarily

Actual market prices are not determined by demand or supply alone but by the point where both meet in equilibrium (Equilibrium).

Characteristics of the equilibrium point:

• The quantity demanded equals the quantity supplied
• No surplus or shortage exists
• Prices tend to stabilize

When prices rise above equilibrium: Sellers are eager to sell more, while buyers reduce their demand, leading to excess supply, which pushes prices back down toward equilibrium.

When prices fall below equilibrium: Buyers want to buy more, while sellers reduce their supply, leading to shortages, which push prices upward back to equilibrium.

Applying demand and supply rules to stock analysis

From a fundamental analysis perspective:
Price movements are driven by changes in investor expectations. For “consumer” stocks, investors are the consumers. When good earnings news is announced, demand increases, pushing prices higher. Conversely, negative news increases supply (selling pressure), causing prices to fall.

From a technical analysis perspective:
Traders use various tools to identify buy and sell signals:

• Price Action: Green candles indicate demand dominance; red candles indicate supply dominance.
• Trend Strength: Making new highs suggests strong demand.
• Support and Resistance: Support levels are points where demand is ready to step in; resistance levels are points where supply is likely to appear.

Demand Supply Zone Technique: Deep timing of trades

This technique identifies moments caused by imbalance between demand and supply, with two main patterns:

Pattern 1: Demand Zone Drop Base Rally (DBR) - Reversal to an uptrend
Price drops sharply (Drop) due to excess supply, then consolidates in a (Base). When selling pressure diminishes and good news arrives, price breaks above the base (Rally), and traders enter on the breakout.

Pattern 2: Supply Zone Rally Base Drop (RBD) - Reversal to a downtrend
Price rises rapidly (Rally) due to excess demand, then consolidates in a (Base). When buying pressure wanes and negative news hits, price breaks below the base (Drop), and traders enter on the breakdown.

Pattern 3: Demand Zone Rally Base Rally (RBR) - Continuation of an uptrend
Price advances (Rally), pauses at a base (Base), then resumes upward movement (Rally), indicating strong demand.

Pattern 4: Supply Zone Drop Base Drop (DBD) - Continuation of a downtrend
Price declines (Drop), pauses at a base (Base), then continues downward (Drop), showing strong supply.

Factors influencing demand and supply in financial markets

Demand side:
When interest rates are low, consumers’ real wealth increases, prompting them to seek returns in stocks. Increased liquidity and high investor confidence stimulate buying.

Supply side:
Companies repurchasing shares reduce the number of shares available. New IPOs increase the total securities. Silent Period restrictions limit large shareholders’ ability to sell.

All these factors work together and are interconnected, causing the price changes we see daily in the markets.

Summary: Demand and supply are dimensions investors must understand

Demand and supply are not just economic theories in textbooks but real forces driving every market transaction. Understanding this mechanism helps investors stop viewing prices as random and instead analyze them based on fundamental principles, recognizing the ongoing battle between demand and supply across the market.

By reading buy and sell pressures, understanding equilibrium and disequilibrium points, trading becomes less guesswork and more analysis-based. Success then comes more naturally.