What are Supply and Demand Zones?

What are Supply and Demand Zones?

For the longest time, I was convinced I could pick the exact moment when the market was going to reverse.  Almost to the pip.  The experts would say it was impossible, but I could do it time and time again.  All I had to do was wait for price to break through and close below support, just like the books say, then enter a short position hoping to get in on the downtrend right before price took off… And take off it would… to all new highs!

What was I doing wrong?  I did what all the Youtube videos said.  I read everything I could on support and resistance “zones”.  Maybe I was drawing them wrong.  Then I stumbled upon it.  Supply and Demand Zones.

To understand them, let’s first simplify how the market moves:

  • There must be buyers for price to go up.
  • There must be sellers for the price to go down.
  • Stoplosses and TakeProfits are how traders typically exit the market.
  • If you are a buyer, you will exit by selling.
  • If you are a seller, you will exit by buying.

There is a saying in poker, “Play the player, not the cards”.  Figuring out what your opponent is thinking could help you win no matter your cards are.  We can apply that to the markets by thinking about how other traders are entering the market.  Here’s an example:

  1. Traders that were waiting on a pullback enter Sell Orders on the reversal, but not all of them may be filled, leaving some Sell Stops lingering above the high.
  2. Traders here will do the opposite, entering Buy Orders on the double bottom reversal signal, targeting extended Take Profits at the previous Highs (number 1).  Again, not all orders will be filled, leaving Buy Stops pending below the lows.
  3. All those lingering Sell Stops are triggered and all the take profits create more sell orders.  To add even more of a push, this will look like a break of resistance on a lower time frame, tricking traders to Buy, placing their Stoplosses below resistance now turned support.  This is known as the “Bull Trap” and will give us more sell orders as price drops.
  4. Same thing happens here for the Buyers that were not tricked by the false breakout.

This may be hard to grasp at first, but it should illustrate why “support and resistance zones” are better thought of as “supply and demand zones”, areas on the chart where orders are being placed by other traders.  Of course price can and will break through these zones, as in the example below:

Price entered the Supply and Demand Zones multiple times soaking up most of the pending orders on both sides.  Trend following traders will also be on the sideline during this consolidation period.  This weakens the “barrier” giving an easier path for price to break through.  The Flag and Wedge Patterns are perfect examples of this.  Price is consolidating, picking off orders until one side wins out, usually continuing the trend.

As always, follow your tested trading plan.  Supply and Demand Zones are not a trading strategy, but a supplement to price action to help you from getting trapped like a donkey.

 

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