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6 Secret Tips For Supply And Demand Forex Trading.
Contents in this article.
Whether we look at strong price turning points, trends or support and resistance areas, the concept of supply and demand is always at the core of it. It can really pay off it you know our 6 tips for supply and demand forex trading.
A strong uptrend can only exist if buyers outnumber sellers – that’s obvious, right?! During a trend, price moves up until enough sellers enter the market to absorb the buy orders. The origin of strong bullish trends is called an accumulation or a demand zone.
Bearish trends are created when sellers outnumber buy orders. Then, price falls until a new balance is created and buyers become interested again. The origin of a bearish trend wave is called a distribution or a supply zone.
Supply and demand drives all price discoveries, from local flea markets to international capital markets. When a lot of people want to buy a certain item with limited quantity, price will go up until the buying interest matches the items available. On the other hand, if no one wants to buy a certain item, the seller has to lower the price until the buyer becomes interested or otherwise there won’t be a transaction.
The 6 tips for supply and demand Forex trading.
Wyckoff’s “accumulation and distribution” theory describes how trends are created. Before a trend starts, price stays in an “accumulation” zone until the “big players” have accumulated their positions and then drive price higher. They can’t just swamp the market with their full orders because it would lead to an immediate rally and they weren’t able to get a complete fill, thus reducing their profits.
A short accumulation zone before a strong breakout can point to unfilled buy interest.
It is reasonably safe to assume that after price leaves an accumulation zone, not all buyers got a fill and open interest still exists at that level. Supply and demand Forex traders can use this knowledge to identify high probability price reaction zones. Here are the six components of a good supply zone:
1) Moderate volatility.
A supply zone typically shows narrow price behavior. Lots of candle wicks and strong back and forth often cancel a supply zone for future trades.
The narrower a supply/demand zone before a strong breakout is, the better the chances for a good reaction the next time typically.
2) Timely exit.
You don’t want to see price spending too much time at a supply zone. Although position accumulation does take some time, long ranges usually don’t show institutional buying. Good supply zones are somewhat narrow and do not hold too long. A shorter accumulation zone works better for finding re-entries during pullbacks that are aimed at picking up open interest.
Good supply zones are somewhat narrow and do not hold too long. A shorter accumulation zone works better for finding re-entries during pullbacks that are aimed at picking up open interest.
Narrow and short accumulation zones, followed by a strong breakout, are more meaningful.
3) The “Spring”
The “Spring” pattern is a term coined by Wyckoff and it describes a price movement into the opposite direction of the following breakout. The spring looks like a false breakout after the fact, but when it happens it traps traders into taking trades into the wrong direction ( read more: Bull and bear traps ). Institutional traders use the spring to load up on buy orders and then drive the price higher.
The “Spring” is a pattern used by professionals to acquire larger positions – buying from amateurs.
4) Strong force leaving the zone.
This point is important. At one point, price leaves the supply zone and starts trending. A strong imbalance between buyers and sellers leads to strong and explosive price movements. As a rule of thumb, remember that the stronger the breakout, the better the demand zone and the more open interest will usually still exist – especially when the time spent at the accumulation was relatively short.
When price goes from selling off to a strong bullish trend, there had to be a significant amount of buy interest entering the market, absorbing all sell orders AND then driving price higher – and vice versa. Always look for extremely strong turning points; they are often high probability price levels.
Strong turning points can offer great re-entry opportunities.
5) Freshness.
If you trade of supply areas, always make sure the zone is still “fresh” which means that after the initial creation of the zone, price has not come back to it yet. Each time price revisits a supply zone, more and more previously unfilled orders are filled and the level is weakened continuously. This is also true for support and resistance trading where levels get weaker with each following bounce.
6) Amateur squeeze.
The Rally-Range-Drop scenario describes a market top (or swing high), followed by a sell-off. The market top signals a level where the sell interest got so great that it immediately absorbed all buy interest and even pushed price lower.
The amateur squeeze allows good and patient traders to exploit the misunderstanding how market behavior of consistently losing traders. It is reasonably safe to assume that above a strong market top and below a market bottom, you’ll still find big clusters of orders; traders who specialize in fake breakouts know this phenomenon well.
Typically, price will go beyond the initial zone to squeeze amateurs and triggers stops and pick up more orders.
How to use the concept of supply and demand?
Most trading concepts sound great in theory, but only if you can actually apply them, it’s worth investing your time and effort to master them. The concept of supply, demand and open interest can be used in 3 different ways:
1 – Reversal trading.
We at Tradeciety specialize in reversal trading (here is our Forex price action course ) and that’s also the best use for supply and demand zones. After identifying a strong previous market turn, wait for price to come back to that area. If a false breakout occurs, the odds for seeing a successful reversal are extremely high.
To create even higher probability trades, combine the fake breakouts with a momentum divergence and a fake spike through the Bollinger Bands.
2 – Support and resistance.
Supply and demand zones are natural support and resistance levels and it pays off to have them on your charts for numerous reasons. Combining traditional support and resistance concepts with supply and demand can help traders understand price movements in a much clearer way. You’ll often find supply and demand zones just below/above support and resistance levels. And while the support and resistance trader is being squeezed out of his trade, the supply and demand traders know better.
3 – Stop Loss and Take Profit.
When it comes to profit placement, supply and demand zones can be a great tool as well. Always place your profit target ahead of a zone so that you don’t risk giving back all your profits when the open interest in that zone is filled. For stops, you want to set your order outside the zones to avoid premature stop runs and squeezes.
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The Forces of Supply and Demand.
Price action and Macro.
The primitive forces of capitalism rule markets like the laws of gravity. Buyers and sellers provoke a battle to find a happy medium agreement in every market on the face of the planet.
As prices dance around on charts, traders are often looking to a number of reasons to explain price movements. And often-times, a number of reasons can be associated with these types of changes.
But at its core – every single price movement is denominated by supply and demand. Positive news means increased demand and lessened supply – equating to higher prices. Negative news usually spells lower demand and increased supply.
Supply and Demand Spelled Out.
Supply is simply the amount available, while demand is the amount that is wanted. Think of supply and demand in the most simple of terms, from the standpoint of any market where buyers and sellers exchange goods. Let’s, for a moment, imagine that you are selling oranges from your own farm at a local market. And you don’t necessarily have to sell all of your oranges, because, after all, you can eat them just as easily as anyone that buys them from you.
But the higher price you can charge for your oranges, in general, the more willing you would be to part with them. If oranges are only fetching 1 dollar per bag, you might be willing to sell 4 or 5 bags. But as price goes up, you decide to make more available. All the way up to 10 dollars per bag, at which point you are more than willing to sell every last orange you have because you can easily take all the money you made and buy something else to eat.
The graph below is called a ‘supply curve,’ and it expresses this relationship. The red line indicates supply, which increases as prices move higher (located on the horizontal axis).
Supply curve, expressing the number of units available (vertical) at various prices (horizontal)
And on the opposite end of the spectrum, we have demand. Now think of the buyer-seller relationship from the vantage point of the consumer. The lower the price, the higher demand will be – the exact opposite of our supply curve. If oranges were only 1 dollar per bag, we’ll we’d want to buy as many as we could because it would be an extreme value. As price increases, our demand weakens because, after all – if oranges are 10 dollars per bag – we can easily find replacement products to use instead of oranges.
Demand curve, expressing the number of units desired (vertical) at various prices (horizontal)
And these two competing forces meet in the marketplace to decide the prices that will be paid and the number of units that will change hands.
This is how price is discovered in a free market environment, the same way that prices are set on trading platforms around the world and it can be expressed in the chart below:
Supply and Demand curve, expressing the most efficient price at which buyers and sellers can meet.
Supply and Demand in the Forex Market.
The analogy of oranges at a farmer’s market is not all too dissimilar from that which takes place every day in the currency market. In some cases, these forces are moving at such high velocity that new traders can have difficulty understanding the granularity of the details; but rest assured - the forces of supply and demand run true to markets whether you’re looking at a tick chart or real estate prices.
The FX market is one of the most voluminous on Earth, and the reason for that is the heavy demand behind the traded assets. Currencies are the basis for the world’s economy. Whenever one economy wants to trade with another economy (provided different currencies are used) an exchange will be required.
Supply and Demand at Work.
Imagine that the Reserve Bank of Australia enacts an interest rate change. An entire chain reaction will be set in motion due to the forces of supply and demand. When rates increase, rollover payments also increase. This means that investors that are holding the trade open at 5pm Eastern Time will receive a higher rate of interest than they would have previously. Incentive has just increased.
So naturally, more traders will want to buy; and fewer traders will want to sell as the opportunity cost of doing so (the rollover payment) has just gotten more expensive.
An example of supply and demand in response to Interest Rate Increase.
Price aims to find a comfortable point, and will increase until there are no more buyers willing to pay that price. At this point, sellers outnumber buyers, and price will respond by moving down.
An example of supply and demand in response to Interest Rate Increase.
After price has moved down far enough (circled in blue), traders will come back into the picture, remembering in the increased interest rate and the additional rollover payment that can be had from holding a long AUDUSD position, and this lower price presents a ‘perceived value.’ As additional buyers enter the picture, price will move up to reflect this increased demand.
And then price will, once again, move so high that traders no longer want to enter the picture at that price level, and price will respond by moving down.
This is but one example of the Supply and Demand relationship; on one time frame… we can even see this relationship playing out in the tick chart of any currency pair.
This is the process of price attempting to find its fair value… it takes place on many different time frames in every market in the world.
In our next article, we’ll tie supply and demand in with support and resistance so that traders can look to use these principals to their advantage.
--- Written by James B. Stanley.
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