The Law of Supply and Demand - Why Investors Need to Understand

In the world of investing, everyone often looks for ways to predict prices—wanting to know if today’s purchase will be profitable or if they should avoid losses. To do this, we need to go back and examine the fundamental mechanisms of the market, which is the laws of supply and demand—the driving forces behind the price structures we see every day in the market, whether it’s stocks, commodities, or even money.

Supply and Demand Explained from the Basics

Simply put, demand (Demand) is how many people want to buy—the number of buyers willing to purchase an asset at a certain price. Supply (Supply) is how many people want to sell—the number of sellers willing to sell at a certain price.

When we plot price against volume, we see two curves—demand curve sloping downward and supply curve sloping upward. The point where they intersect is the “equilibrium price,” which is considered fair in the market—where buying and selling pressures are balanced.

Key Rules to Know

First—The laws of supply and demand tell us that:

As prices rise, fewer people want to buy, but more want to sell. Conversely, when prices fall, more people want to buy, and fewer want to sell. This happens due to two reasons:

• Income Effect: When prices are low, purchasing power increases—it’s like your money is worth more.
• Substitution Effect: When one asset becomes expensive, investors turn to cheaper alternatives.

Equilibrium Price Results from the Clash of These Laws

The importance of the laws of supply and demand is that they explain where the actual prices come from. Often, investors focus only on the numbers but don’t understand that those numbers result from the battle between buyers and sellers.

Imagine: If today a large number of buyers flood into the market but supply is limited, what happens? Prices will rise because people are willing to pay more to acquire the asset.

Conversely, if many sellers are trying to sell but buyers are scarce, prices will fall as sellers lower their prices to find buyers.

This fluctuation is driven by various factors:

• Demand Side: Economic conditions, investor confidence, interest rates, news expectations, changing preferences, and consumer numbers.
• Supply Side: Production costs, tax policies, technology, competition levels, weather, and natural factors.

Financial Markets—The Laws of Supply and Demand in a New Form

In stock or financial markets, the core principles of supply and demand still apply but are hidden under different terms:

Buyers represent demand—people wanting to buy shares.
Sellers represent supply—people wanting to sell shares.

The stock prices we see on screens every second are the result of the ongoing battle between these two forces.

What causes demand or supply to change?

• Earnings Announcements: If a company reports higher-than-expected profits, buyers rush in.
• News and Events: Good or bad news, political developments, economic reports.
• Corporate Decisions: Issuing new shares or buybacks affect the number of shares available.
• Market Liquidity: The amount of money flowing into or out of the market.
• Investor Confidence: From institutions, retail investors, or foreign investors.

Using the Laws to Predict Stock Prices

If investors can “read” supply and demand, they can better forecast prices. Two popular methods are:

1. Fundamental Analysis

Viewing stock prices as reflecting the intrinsic value of a company, not just the stock’s paper price.

• If Q1 earnings are good → demand increases → price rises.
• If Q1 earnings disappoint → supply increases → price drops.
• If economic signals are positive → investors expect growth → demand increases → price rises.

2. Technical Analysis

Looking at “signs” of past buying and selling pressures in candlestick charts and trend lines.

Reading Candlesticks:

• Green candles (close higher than open): Buying pressure dominates; end of day at higher price.
• Red candles (close lower than open): Selling pressure dominates; end of day at lower price.
• Doji (open and close near the same price): Indecision; no clear trend.

Support & Resistance:

• Support: Price level where buying interest previously prevented further decline.
• Resistance: Price level where selling interest previously prevented further rise.

Demand and Supply Zones—Real Trading Techniques

A popular method is identifying demand zones and supply zones by observing:

1. Rapid Price Movements (“Rally” and “Drop”)

• When price surges quickly upward (Rally), then pulls back slightly and continues higher (Rally Base Rally = RBR), it indicates a demand zone—buyers are willing to step in at that area.
• Conversely, if price drops sharply (Drop), then pulls back slightly and drops again (Drop Base Drop = DBD), it indicates a supply zone—sellers are eager to sell at that level.

2. Reversal Points

Often, prices move too far in one direction, attracting the opposite side:

• Excessive upward movement attracts sellers (Drop Base Rally - DBR), leading to a reversal.
• Excessive downward movement attracts buyers (Rally Base Drop - RBD), leading to a bounce.

Traders who identify these points can enter trades at breakout levels or reversals.

Why Do Investors Need to Understand the Laws of Supply and Demand?

First, they explain why prices change—not just that they do.

Second, they serve as a thinking tool—helping investors avoid superficial “support-resistance” analysis without understanding why those levels matter—like knowing that a resistance level exists because of a large sell order waiting there.

Third, these laws are universal—applying to stocks, bonds, cryptocurrencies, commodities, and currencies—all assets with prices driven by supply and demand.

Summary

The laws of supply and demand are not just dry economic formulas but the real rules of the market game. Every price change results from an imbalance between buyers and sellers.

Investors who understand this will see the market with a “fish’s eye”—seeing where the money (liquidity) flows and where the price (fish) swims.

To master this principle, try applying it to the assets you follow. Look for demand and supply zones, identify support and resistance levels, and analyze where buying or selling pressure is strongest. The more you practice, the better you’ll become at reading the market accurately.