Supply and demand: A summary of what investors need to know to predict prices

When you look at a stock price chart that keeps declining, you might wonder why it’s falling. If you understand the principles of supply and demand, you can answer that question. You can also predict which direction prices will move next. This article summarizes the essential knowledge about supply and demand — not just as economic theory, but as a real tool to help investors make smarter decisions.

What Causes Prices: The Basic Relationship Between Buying and Selling Forces

Imagine a type of fish that all fishermen like. If there are many fishermen but not enough fish, the price of fish will go up. Conversely, if there aren’t many fishermen but plenty of fish, the price will fall. This is the reality of all markets, including the stock market.

Supply and demand in simple terms are the desire to buy (demand) and the desire to sell (supply). When more people want to buy, buying pressure is strong. When more people want to sell, selling pressure is strong. The point where these forces meet is where the price stabilizes — called equilibrium.

Importantly, prices are not determined solely by the desire for the product itself. They are set by the balance between buyers and sellers at that moment.

The Law of Demand: Why Do Prices Rise When Demand Decreases?

When the price of a certain item goes up, the first thing that happens is people tend to buy less. But why? Shouldn’t good things attract more buyers?

The answer lies mainly in two effects: the income effect and the substitution effect.

Imagine you have a certain amount of money. If the price of the product you want drops, your money can buy more of it. You’re no longer limited in how much you can buy, so your demand increases — that’s the income effect.

The substitution effect occurs when a product’s price drops compared to similar products. If it becomes cheaper, you might choose it over others, increasing demand for that product.

Factors Influencing Demand Beyond Price

While price is the most influential factor, other elements can shift the entire demand curve:

• Buyers’ income — Wealthier people tend to buy more.
• Tastes and trends — If something becomes fashionable, demand rises.
• Prices of related goods — If the price of a substitute drops, demand for the original may decrease, or vice versa.
• Number of buyers — More buyers mean higher demand.
• Future expectations — If people expect prices to rise, they may buy more now.

Supply: The Other Side of the Coin

If demand is what buyers want, supply is what sellers are willing to offer.

The law of supply is the opposite of demand: as prices go up, sellers are willing to supply more; as prices fall, they supply less, because they don’t want to sell below their costs.

Factors affecting supply are often related to production costs — higher costs mean sellers want higher prices and are less willing to supply at lower prices. Conversely, technological advances that lower costs encourage more supply.

Other factors include the number of competitors, technology, and government policies (taxes, regulations).

Equilibrium: The Market’s Peaceful Point

When buying and selling forces balance at a certain price, the market reaches equilibrium. Why does the price tend to stay there?

• If the price tries to go higher, sellers see an opportunity to sell more, but buyers become less willing to buy at higher prices, leading to excess supply and a price decrease.
• If the price drops, buyers want to buy more because it’s cheaper, but sellers are less willing to sell at lower prices, leading to excess demand and a price increase.

This self-correcting process is often called the “invisible hand” — the market naturally adjusts toward balance.

Financial Markets vs. Commodity Markets: What Drives Stock Prices Differently?

The supply and demand principles apply to stock markets too, but the factors influencing buying and selling are different from those in commodity markets.

In financial markets, demand is driven by:

• Overall economic conditions — Low interest rates make stocks more attractive.
• Company performance — Higher profits increase demand for stocks.
• Liquidity — When banks release more money, investors have more to invest.
• Market sentiment — Positive news boosts buying; negative news prompts selling.

Supply factors include:

• Share buybacks — Companies repurchasing their own shares reduce supply.
• New IPOs — More companies going public increase supply.
• Regulations — Rules can limit or encourage share issuance and trading.

How to Read True Demand from Candlesticks and Price Charts

Traders and investors look for signals of supply and demand in price charts and candlestick patterns.

• Green candles (close higher than open) indicate buying pressure winning over selling pressure. Longer candles suggest stronger forces.
• Red candles (close lower than open) show selling pressure dominating.
• Doji candles (open and close at similar levels) suggest indecision, with forces roughly equal — often a pause before the next move.

Trend analysis helps too: if prices make higher highs, demand is strong; if they make lower lows, supply dominates.

Selling Pressure: Why Do Stocks Suddenly Shift from Uptrend to Downtrend?

For example, a stock (Company A) is trending upward, and traders buy in anticipation of continued gains, pushing the price from 80 to 100. Suddenly, bad news emerges, causing investors to sell to lock in profits. The increased selling volume causes the price to drop quickly.

This is when selling demand overtakes buying demand, shifting the market to a new equilibrium at a lower price.

Support and Resistance: Reading Signals from Accumulated Demand and Supply

Support is a price level where demand tends to gather, preventing the price from falling further. Investors see it as a good entry point, so buying activity increases there.

Resistance is where supply accumulates, capping upward movement. Investors see it as a profit-taking zone, so selling activity increases.

Breaking through resistance indicates demand has overwhelmed supply, and prices may continue upward.

Trading Strategies: Using Supply and Demand Zones to Predict Price Trends

Professional traders often use “Demand and Supply Zones” to time their trades. The idea is to identify areas where prices have sharply moved up or down (showing imbalance), then pause or consolidate (indicating a potential reversal).

When the price breaks out of these zones, it signals that the original force has regained control, and the trend may continue.

For example, if prices drop sharply (excess supply) and then form a base, a breakout above that base suggests demand is returning, and prices may rise further.

Summary: Supply and Demand — Essential Tools for Investors

Economists, traders, and investors all rely on supply and demand principles to understand and predict price movements. Recognizing that prices are the result of a balance between buyers and sellers allows for deeper market analysis.

In short: observe buying strength — if it increases, prices tend to rise; observe selling strength — if it increases, prices tend to fall. The key is understanding which side will gain momentum next, which depends on various factors and your experience in analyzing real market data. Developing this intuition through practice will enhance your investing instincts.