How the purchase volume and price of goods are related: Understanding the law of demand in investing

In financial markets, we see asset prices constantly changing. Investors often wonder what drives these price movements. The answer is different from common assumptions — it’s not just news or trends, but an age-old equation in economics: the relationship between demand and supply.

Basic Relationship: Quantity Demanded and Price Move in Opposite Directions

The fundamental law of economics states that demand (the quantity consumers want to buy) and the price of a good do not move together. When prices rise, demand usually decreases; when prices fall, demand tends to increase.

Why is that? There are two main reasons:

• Income Effect: When prices drop, the real value of our money increases, allowing us to buy more with the same amount.
• Substitution Effect: Lower prices make the good more attractive compared to alternatives, leading consumers to buy more.

Factors Influencing Quantity Demanded: Beyond Price

Demand isn’t driven by price alone; other factors also have equal influence:

• Consumer Income: Higher income generally increases demand.
• Prices of Substitutes: If a substitute’s price rises, consumers switch to this good.
• Preferences and Beliefs: Trends and consumer confidence directly affect demand.
• Number of Consumers: More consumers mean higher total demand.
• Future Expectations: If consumers expect prices to rise, they buy more now.

Supply: The Other Side of the Coin

If demand explains consumer behavior, supply explains seller behavior. The law of supply reflects the demand law: the quantity sellers are willing to offer is proportional to the price.

When prices go up, sellers and producers are more motivated to supply more because of higher profits. Conversely, when prices fall, supply decreases.

Factors affecting supply include:

• Production Costs: Higher costs reduce supply.
• Technology: Improved technology increases supply.
• Number of Sellers: More sellers lead to higher supply.
• Future Price Expectations: Sellers may hold back if they expect higher prices later.

Equilibrium: Where Demand Meets Supply

Actual market prices aren’t set by demand or supply alone but at their intersection — the equilibrium point.

At this point, the quantity buyers want to buy equals the quantity sellers want to sell, and prices and quantities stabilize temporarily.

• If prices are above equilibrium, there’s a surplus — more goods supplied than demanded, pushing prices down toward equilibrium.
• If prices are below equilibrium, there’s a shortage — more demand than supply, pushing prices up toward equilibrium.

How These Relationships Affect Financial Markets

In stock and asset markets, demand and supply don’t physically set prices but are the main drivers of valuation.

• Macroeconomic factors such as interest rates, economic growth, and liquidity influence demand.
• News, positive or negative, about companies or markets, immediately impacts selling pressure.
• Market sentiment — confidence, fear, and intentions — can rapidly change demand.

Using Demand and Supply in Technical Analysis

Modern technical analysts use demand-supply principles to interpret price charts:

• K-line (Candlestick): Green candles (close higher) indicate demand dominance; red candles (close lower) indicate supply dominance.
• Trend: Prices making new highs suggest strong demand; new lows suggest strong supply.
• Support & Resistance: Areas where prices frequently reverse are zones of balanced demand and supply.

Demand Supply Zone: Modern Application

Demand Supply Zones apply the concept of price equilibrium to identify entry and exit points:

• Reversal Up (DBR): Rapid price drops (excess supply) form a base; when price breaks above this zone, it signals demand has overtaken supply.
• Reversal Down (RBD): Rapid price increases (excess demand) form a base; breaking below this zone indicates supply has overtaken demand.
• Continuation (RBR, DBD): Strong demand (uptrend) or supply (downtrend) resumes after a brief consolidation.

Summary

The relationship between quantity demanded and price, according to the law of demand, is not just a basic economic concept but a practical tool for valuation. It directly relates to investment decisions—whether fundamental or technical. Investors can apply these principles to better understand price movements and make more informed trading decisions based on solid foundations.