Supply & Demand

A full study of the laws of supply and demand is outside the scope of this user guide. However, the following basic ideas should be understood:
  • 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.

This is a good clue. Due to the habits of the market participants there might well be residual supply (or demand) at the same level as the origin of the imbalance. In particular, the imbalance indicates that there were unfilled orders at those prices, these orders might still reside there.

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.


Not all supply / demand zones are created equal. Some will behave “better” than others, that is, they are more likely to provide a tradable reaction. The indicator tries to identify good zones, and there are a number of parameters that can be tweaked for optimum results. In general, we are looking for a small to medium zone origin (not too many bars and not too few) and a strong exit from the zone (i.e. the right-leg move), the left-leg is usually not critical.

Input Parameters





Screenshots





Further Information

Further information may be found on this blog by searching for tagged articles.


Availability

The indicators are available to purchase for MarketScope 2.0 via the Store page. You can also request a trial version by contacting me (use the link in the side bar).