What are supply and demand, and how do they play a crucial role in the financial markets?

Investors often notice that stock prices never stop changing. Sometimes they surge, sometimes they plummet. These movements are not random but caused by two opposing forces constantly battling each other: supply and demand, which are fundamental to setting prices in both general markets and financial markets.

Hidden Price Phenomena: What Are Supply and Demand?

In each second of trading stocks, there is a buyer on one side and a seller on the other. The balance or imbalance of these forces creates the price—called supply and demand—which is a basic concept that’s not as complicated as it seems.

Demand is the quantity of goods or services that consumers or investors want to buy at various price levels. When plotted on a graph, it shows the demand curve, illustrating the relationship between price and quantity desired.

Supply is the quantity of goods or services that producers or sellers want to offer at different price levels. Its graph, the supply curve, shows the same relationship from the seller’s perspective.

The key point is that these two lines intersect at a point called equilibrium, where supply and demand balance. This is the point where price and quantity are stable and tend not to change until new factors come into play.

The Main Rules of Supply and Demand: Why Do Prices Decide Themselves?

The law of demand states that when prices go up, demand decreases; when prices go down, demand increases. This is due to two reasons:

• Income Effect: When prices fall, consumers’ purchasing power increases, allowing them to buy more.
• Substitution Effect: When a product’s price drops, consumers tend to buy that product instead of similar, more expensive alternatives.

The law of supply works in the opposite direction: when prices rise, sellers are willing to supply more because they can earn higher profits. When prices fall, they want to supply less to maintain profitability.

Factors That Drive the “Game” of Supply and Demand

It’s not just prices that influence supply and demand; many other factors do:

Factors affecting demand:

• Consumers’ income or government subsidies
• Preferences and tastes
• Prices of substitute or complementary goods
• Number of consumers in the market
• Future price expectations
• Seasons and psychological factors like consumer confidence

Factors affecting supply:

• Production costs
• Technology used
• Number of producers or competitors
• Future price expectations of sellers
• Taxes and price controls
• Weather and natural disasters

Applying to Financial Markets: Why Are Stocks Considered Goods?

Stocks and other financial assets can be viewed like regular goods, with buyers and sellers on both sides. The difference is that demand for stocks doesn’t come from consuming a product but from expectations about the company’s future.

For example, good news like a 50% profit increase causes demand (buying interest) to spike immediately, as investors hope for high returns. Conversely, bad news prompts existing shareholders to sell quickly, increasing supply and lowering prices.

How to “Read” Supply and Demand from Trading

Experienced traders can “see” supply and demand through various tools:

Candlestick Analysis:

• Green candles (close > open): buying pressure exceeds selling pressure
• Red candles (close < open): selling pressure exceeds buying pressure
• Doji candles (close ≈ open): forces are in balance

Support & Resistance Levels:

• Support: price level where most investors see value and are willing to buy (demand zone)
• Resistance: price level where investors see it as expensive and are willing to sell (supply zone)

Trend Analysis:

• Higher highs: demand outweighs supply
• Lower lows: supply remains strong
• Range-bound prices: market is in balance

Demand and Supply Zones: Exploiting Imbalance

A popular method to catch trading opportunities is studying Demand and Supply Zones—areas where supply and demand are out of balance.

Reversal Patterns:

DBR (Demand Zone Drop Base Rally): Uptrend from buying demand

• Price drops sharply due to excess selling
• Price stabilizes and consolidates (base) as buying interest returns
• When good news comes out, price breaks above the zone and rallies
• Traders buy on breakout with stop-loss orders

RBD (Supply Zone Rally Base Drop): Downtrend from selling pressure

• Price surges upward due to excess buying
• Price consolidates (base) as selling resumes
• Negative news causes price to break below the zone and fall further
• Traders sell on breakdown with stop-loss orders

Continuation Patterns:

RBR (Rally Base Rally): Uptrend continuation

• Price continues rising on strong buying
• Consolidates (base) during minor pullbacks
• Good news triggers breakout above resistance, pushing prices higher

DBD (Drop Base Drop): Downtrend continuation

• Price continues falling on strong selling
• Consolidates (base) during minor rebounds
• Negative news causes breakdown below support, pushing prices lower

The Importance of Understanding Supply and Demand

Grasping supply and demand isn’t just about learning economic theory; it’s about giving investors a lens to see what drives the market. When you understand which factors increase demand and which increase supply, you can more accurately predict price directions.

Supply and demand are not just academic terms—they are real forces that drive prices in markets for goods, real estate, and finance. Applying these principles in your investment decisions helps you avoid emotional trading and make decisions based on market dynamics.