- When supply and demand are in equilibrium (balance), the price of an asset will trade sideways - often in a narrow range.
- When supply exceeds demand, there is no equilibrium (imbalance), the price of an asset will fall in order to attract buyers at lower prices.
- When demand exceeds supply, there is no equilibrium (imbalance), the price of an asset will increase in order to attract sellers at higher prices.
- Financial markets are fractal, and the same basic rules apply at any time-frame.
Finding the “true” supply or demand is not simple, since markets are complex, particularly since different participants operate on different time-frames. However, there are some tell-tale clues in the price action. Remember that areas of supply/demand equilibrium (balance) are observed as sideways price action. If price moves quickly and aggressively away from such areas we know that an imbalance was observed, and the direction of the move tells us whether demand exceeded supply or supply exceeded demand.
Even in the absence of “institutional order flow” there are a number of other reasons why these sharp transitions from balance to imbalance are useful places to trade around. For example, the behaviours of break-out traders, trapped traders exiting bad positions, etc.
Let’s look at the anatomy of a transition from balance to imbalance. This example depicts a demand zone, but the same principals also apply for supply zones.