Demand and supply are the primary tools for understanding the movement of stock and asset prices.

Why do stock prices sometimes go up and sometimes go down? The answer lies in what is called demand and supply, which is a fundamental concept in economics that explains price movements in the market. Investors who understand this concept can better predict future prices and time their buy and sell decisions more accurately.

What Are Demand and Supply?

Demand and supply are not just economic terms but the main forces that create market price equilibrium. When there is demand (buying interest) high and supply (selling interest) low, prices tend to rise. Conversely, when supply is high and demand is low, prices tend to fall.

Understanding Demand

Demand refers to the desire to buy goods or services at various price levels. When plotted on a graph, it forms the demand curve, which shows the relationship between price and quantity.

The main rule of demand states that as prices increase, the quantity demanded decreases, and as prices decrease, demand increases. Price changes affect two main effects: income effect and substitution effect. When prices fall, consumers have more money in their pockets, enabling them to buy more. When prices drop, consumers are also more likely to choose this cheaper option over more expensive alternatives.

Other factors influencing demand besides price include consumers’ income, tastes and preferences, the number of buyers, future price expectations, and external factors such as seasons, government policies, technology, and consumer confidence.

Understanding Supply

Supply refers to the willingness of sellers to offer goods or services at various price levels. When plotted, it creates the supply curve, showing the quantity sellers are willing to supply at different prices.

The main rule of supply states that as prices increase, sellers are willing to supply more, because they see higher profit opportunities. When prices decrease, they tend to supply less.

Factors affecting supply include production costs, prices of alternative products, the number of competitors, production technology, future price expectations, tax policies, currency fluctuations, and access to financing.

Equilibrium Point

The actual market price occurs where the demand and supply curves intersect, called the equilibrium point. At this point, the quantity and price tend to stabilize because:

• If the price rises above equilibrium, sellers will supply more while buyers will demand less, leading to excess supply and a downward pressure on price.
• If the price falls below equilibrium, buyers will want to buy more while sellers will supply less, causing shortages and upward pressure on price.

Factors Affecting Demand and Supply in Financial Markets

In stock and financial asset markets, demand and supply are influenced by more complex factors.

Demand Factors

Macroeconomic factors such as interest rates, economic growth, and inflation influence investment demand. Lower interest rates make stocks more attractive as alternative investments.

Market liquidity: More money flowing into the market increases the demand for risky assets.

Investor confidence: Positive outlooks on the economy, corporate earnings, or political stability boost demand, while negative news reduces it.

Supply Factors

Decisions by listed companies: When companies issue new shares, supply increases; share buybacks reduce supply.

New listings: IPOs add new securities to the market, increasing supply.

Policies and regulations: Market rules and regulations can limit or expand the amount of assets available for trading.

Applying Demand and Supply to Stock Price Analysis

Investors can use these concepts in two main ways: fundamental analysis and technical analysis.

Fundamental Analysis

When stock prices rise, it indicates higher demand, possibly due to positive earnings forecasts, profit growth, or improved company valuation. Conversely, falling prices may reflect investor concerns about future performance.

Technical Analysis

Traders use various tools to gauge demand and supply:

1) Candlestick Analysis

• Green candles (close > open) suggest buying strength; prices may continue upward.
• Red candles (close < open) indicate selling pressure; prices may decline.
• Doji candles (close ≈ open) show indecision, with no clear trend.

2) Trend Analysis

• Higher highs and higher lows suggest strong demand and an uptrend.
• Lower lows and lower highs indicate supply dominance and a downtrend.
• Sideways movement reflects balanced demand and supply.

3) Support and Resistance Levels

• Support: a price level where demand is strong enough to prevent further decline; prices tend to bounce back up.
• Resistance: a level where supply exceeds demand, causing prices to reverse downward.

Using Demand and Supply Zones to Time Trades

Demand and supply zones combine all the above ideas by identifying points where the market is out of balance and then returning to equilibrium.

Reversal Trading

1) Demand Zone Drop Base Rally (DBR) — Bullish Reversal

• Starts with excess supply, causing rapid price drop (Drop).
• Price consolidates at a support area (Base).
• Positive news or catalysts cause price to break out upward (Rally).
• Traders buy on breakout with stop-loss below the zone.

2) Supply Zone Rally Base Drop (RBD) — Bearish Reversal

• Begins with excess demand, pushing price sharply higher (Rally).
• Price consolidates at a resistance area (Base).
• Negative news or catalysts cause price to break down (Drop).
• Traders sell on breakdown with stop-loss above the zone.

Trend Following

1) Demand Zone Rally Base Rally (RBR) — Uptrend Continuation

• Price rallies to new highs, consolidates (Base).
• Positive factors strengthen demand, leading to another rally.

2) Supply Zone Drop Base Drop (DBD) — Downtrend Continuation

• Price drops to new lows, consolidates (Base).
• Negative factors strengthen supply, leading to further decline.

Summary

Demand and supply are fundamental concepts essential for understanding price movements in markets. Whether through fundamental or technical analysis, being able to read signals of demand and supply gives traders and investors an advantage in predicting prices and timing trades. Mastery of this requires continuous practice and analysis of real market data to effectively apply these principles.