Why study supply and demand? Key strategies for investors to forecast prices

Studying supply and demand is not just about learning economic theories in the classroom; it is the key to understanding price movements in the financial markets. Every investor should study these concepts to improve their decision-making skills. Buying and selling demand are the main drivers of all price movements in the market, and being able to accurately read these forces will help you predict price directions more precisely.

Supply and Demand: Essential Tools Investors Must Understand for Investment Decisions

Before applying supply and demand principles to investing, we need to understand what these concepts mean and how they relate to each other.

Demand refers to the desire to buy goods or services at various price levels. When graphed, the demand curve shows the relationship between price and the quantity buyers want. According to the law of demand, as prices rise, demand decreases; conversely, as prices fall, demand increases. This relationship is driven by two reasons: income effect (lower prices leave consumers with more money) and substitution effect (people switch to cheaper alternatives).

Supply refers to the willingness to sell goods or services at different price levels. The supply curve illustrates the relationship between price and the quantity sellers are willing to offer. According to the law of supply, higher prices encourage more selling; lower prices lead to less supply.

Equilibrium is the point where the supply and demand curves intersect. At this point, the quantity buyers want matches the quantity sellers want to sell. Prices and quantities tend to stabilize here because if prices rise, excess supply (inventory) will push prices down; if prices fall, shortages will push prices up.

Factors That Cause Changes in Supply and Demand

Besides price, many other factors influence shifts in supply and demand. In financial markets, these factors often interact and are interconnected.

Factors Affecting Demand:

• Macroeconomic factors (economic growth, inflation rate, interest rates)
• Liquidity in the financial system (money supply)
• Investor confidence (future expectations)
• Consumer tastes and preferences
• Number of consumers
• Expectations about future prices

Factors Affecting Supply:

• Production costs
• Company policies (capital raising, share buybacks)
• Technology and innovation
• Number of sellers/producers
• Future price expectations
• Climate and natural disasters
• Regulations and legal requirements

Applying Supply and Demand Principles to Stock Price Analysis

Stocks are commodities, so the laws of supply and demand can be applied. Stock prices reflect investors’ buying demand and shareholders’ selling supply.

Fundamental Analysis: Stock prices are viewed as representations of a company’s intrinsic value (market cap). Factors influencing earnings forecasts and growth prospects will shift demand or supply. Positive news encourages investors to buy at higher prices or in larger volumes, raising the price. Negative news prompts shareholders to sell at lower prices, decreasing the price.

Technical Analysis: Traders use various tools to interpret buying (demand) and selling (supply) pressures based on price movements and trading volume.

1) Candlestick Analysis

• Green candles (close > open) indicate strong buying pressure, suggesting an upward trend.
• Red candles (close < open) indicate strong selling pressure, suggesting a downward trend.
• Doji candles (close ≈ open) show indecision, with potential for price reversal.

2) Trend Evaluation

• Higher highs indicate increasing demand or buying strength, suggesting continued upward movement.
• Lower lows indicate increasing supply or selling pressure, suggesting continued downward movement.
• Sideways movement indicates balanced forces.

3) Support and Resistance Levels

• Support: a price level where buying interest is strong enough to prevent further decline, often leading to a bounce.
• Resistance: a price level where selling interest is strong enough to prevent further rise, often causing a pullback.

Example of Trading Timing Using Demand and Supply Zones

Demand and supply zones are crucial techniques for applying supply and demand principles in trading, identifying points where price has recently lost equilibrium and is likely to find a new balance.

Case 1: Reversal

Demand Zone - Drop Base Rally (DBR)
Occurs after excessive selling. Price drops sharply (Drop), then consolidates (Base). Good news can trigger strong buying, pushing price through the base and reversing upward (Rally). Traders can buy when price breaks above the base from below.

Supply Zone - Rally Base Drop (RBD)
Occurs after excessive buying. Price rises sharply (Rally), then consolidates (Base). Bad news can trigger strong selling, pushing price below the base and reversing downward (Drop). Traders can sell when price breaks below the base from above.

Case 2: Continuation

Demand Zone - Rally Base Rally (RBR)
Price rises rapidly (Rally), then consolidates (Base). When new positive factors emerge, buying resumes, pushing price through the base and rallying again.

Supply Zone - Drop Base Drop (DBD)
Price drops sharply (Drop), then consolidates (Base). Negative factors cause selling to intensify, pushing price below the base and dropping further.

Why Is Studying Supply and Demand Important for Investors?

1. More Accurate Price Predictions: Understanding the forces behind price movements allows investors to better forecast future trends.

2. Better Entry and Exit Points: Identifying where supply or demand shifts helps determine optimal buy and sell points.

3. Improved Risk Management: Recognizing reversal signals enables setting effective stop-loss levels.

4. Clearer View of Actual Trading Volume: High volume indicates genuine market conviction, while low volume may suggest weak or false movements.

Summary: From Study to Practice

Studying supply and demand is not just about passing economics exams; it builds a foundation that enables investors to make smarter, more confident investment decisions.

This knowledge applies to both fundamental analysis (assessing company performance and intrinsic value) and technical analysis (reading signals from price and volume). To effectively use these concepts, one must understand them thoroughly, then practice by observing real market price and volume movements. Over time, this will lead to a clearer understanding of market behavior and more effective long-term investment decisions.