Understanding the rules of supply is to accurately assess stock prices.

The law of supply is a fundamental principle that explains the relationship between the quantity of goods offered by sellers and the set price. It is a key to understanding price movements in the market and investment decisions. Although many people know that demand and supply influence prices, not everyone can effectively apply this concept.

Demand and Supply: Differences and Their Role in Price

Demand refers to the quantity of goods or services that consumers are willing to buy at various price levels. When plotted on a graph, it forms a downward-sloping demand curve, reflecting that as prices decrease, buyers want to purchase more, and as prices increase, demand decreases. This phenomenon results from two effects: the income effect, where lower prices increase consumers’ purchasing power, and the substitution effect, where consumers switch to this product over others when its price becomes more competitive.

Supply, on the other hand, is the quantity of goods that sellers are willing to offer at different prices. The law of supply states that as prices rise, sellers are willing to supply more because the expected profit increases. Conversely, when prices fall, they tend to supply less. The supply curve is upward-sloping.

Equilibrium Price: The Market’s Balance Point

The actual market price we observe is not determined by demand or supply alone but by the point where the demand and supply curves intersect, called the equilibrium price. At this point, the quantity consumers want to buy equals the quantity sellers want to sell, resulting in no pressure for the price to change.

If the price rises above the equilibrium, sellers want to sell more, but buyers want to buy less, leading to excess supply and downward pressure on price. Conversely, if the price drops below equilibrium, buyers want more, but sellers supply less, causing shortages and upward pressure until the market returns to equilibrium.

Factors Affecting Demand and Supply

Besides price, other factors influence demand, such as consumer income, tastes, the number of buyers, and future price expectations. In financial markets, macroeconomic factors like interest rates, economic growth, and liquidity also impact asset demand.

For supply, key factors include production costs, technology, tax policies, and sellers’ expectations about future prices. In stock markets, corporate policies like share buybacks or capital increases can alter the available share volume.

Applying Demand and Supply Rules in Stock Analysis

In fundamental analysis, demand and supply are reflected through changes in a company’s valuation. When investors anticipate strong growth, demand for the stock increases, and fewer shareholders are willing to sell, pushing prices higher. Conversely, negative news causes demand to decrease and more shareholders to sell at lower prices.

From a technical analysis perspective, various tools help track demand and supply:

• Candlestick Analysis: Green candles (close higher than open) indicate strong demand, while red candles (close lower than open) suggest supply pressure. Doji candles (close near open) show indecision and battle between buyers and sellers.

• Support & Resistance: Support levels are price points where buying interest is strong enough to prevent further decline, while resistance levels are where selling interest caps upward movement. These points help predict potential price reversals.

Trading Demand and Supply Zones to Capture Market Moves

Demand and supply zones are popular trading strategies based on the principles of supply and demand, identifying moments when price loses equilibrium and moves rapidly, then consolidates to find a new balance. There are two main types:

Reversal Trading: Occurs when price moves to a zone and then reverses direction, such as:

• Demand Zone Drop Base Rally (DBR): Price drops sharply, consolidates, then rallies.

• Supply Zone Rally Base Drop (RBD): Price rises sharply, consolidates, then drops.

Continuation Trading: Happens when price continues in the same direction after a zone, such as:

• Demand Zone Rally Base Rally (RBR): Uptrend resumes after consolidation.

• Supply Zone Drop Base Drop (DBD): Downtrend continues after consolidation.

Summary

The law of supply and demand and their principles are fundamental for investors to understand how prices move. Whether through fundamental or technical analysis, the ability to read buying and selling pressures enhances decision-making accuracy and effectiveness. Regular practice and testing these strategies in real scenarios are crucial steps in developing trading skills for all investors.