Supply and demand rules: Why investors need to understand this

The law of supply and demand isn’t just a classroom topic in economics. It’s a tool used daily by banks, traders, and investors to predict where stock prices are headed. If you understand this rule, you’ve already grasped the heart of the market.

Buy and sell demands are constantly competing. When one side wins, that side determines the price direction. In this article, we’ll explore what supply and demand are, how they influence pricing, and how investors can use this knowledge to their advantage.

Understanding Buy and Sell Demands

To understand the law of supply and demand, we need to start with the basics: what exactly are demand and supply?

What Buyers Want: Demand

Demand is the quantity of goods or services consumers want to buy at various prices. When plotted on a graph, it creates a demand curve showing:

• At this price, how much buyers want
• The maximum price buyers are willing to pay to get their desired quantity

Why does demand change with price?

Because of the “income effect” and the “substitution effect.”

Income Effect: When prices fall, your purchasing power increases, allowing you to buy more with the same money.

Substitution Effect: When a product becomes cheaper, it looks more attractive compared to alternatives, so you buy this instead.

Other factors influencing consumption include:

• Consumer income
• Prices of competing or complementary goods
• Tastes and preferences
• Number of consumers in the market
• Expectations of future prices
• Seasons, technological advances, government policies, and economic confidence

What Sellers Offer: Supply

Supply is the quantity of goods or services producers are willing to sell at different prices. Its graph, called the “supply curve,” indicates:

• How much sellers are willing to supply at each price
• The lowest price at which sellers are willing to sell a given quantity

Notice: As prices rise, sellers want to supply more because of higher profits. Conversely, when prices fall, they tend to supply less.

Factors influencing sellers’ willingness to supply include:

• Production costs
• Prices of alternative products
• Number of sellers in the market
• Technology and production efficiency
• Future price expectations
• Weather, natural disasters, tax policies, exchange rates, and access to funding

Equilibrium Point: When Buy and Sell Meet

Knowing only that buyers want to buy and sellers want to sell isn’t enough. The actual market price is set where the demand and supply curves intersect—called “equilibrium.”

At this point, prices and quantities tend to stabilize. Why is that?

• If price rises above equilibrium: Sellers want to supply more, but buyers buy less, leading to surplus, which pushes prices back down.
• If price drops below equilibrium: Buyers want more, but sellers supply less, leading to shortages, which push prices back up.

Factors That Move Prices in Financial Markets—Essential Knowledge for Trading

Now, it gets more complex because in financial markets (stocks, currencies, commodities), demand and supply aren’t just about buying food. Many factors influence both sides.

Demand Side: What Makes Buyers Spend?

Macroeconomic Factors: When the economy grows well, interest rates are low, or inflation is low, investors are more willing to risk their money in assets. When interest rates rise, they tend to sell off stocks quickly.

Liquidity: When markets are flush with money, investors have more to invest. When liquidity dries up, they pull back.

Confidence: Good news about economic growth, corporate profits, political stability encourages market participation. Bad news causes investors to withdraw.

Supply Side: What Causes Sellers to Release Assets?

Corporate Policies: Companies issuing new shares (IPOs) or buying back shares change the supply in the market. New shares increase supply; buybacks decrease it.

Market Nature: New companies entering the market increase available securities, possibly affecting short-term prices.

Regulations: Policies from stock exchanges or regulators, like restrictions on early selling (e.g., silent periods), influence trading volume.

Letting Stock Prices Speak—Deeper Demand and Supply Analysis

Stocks are commodities, so their prices are driven by supply and demand. But unlike physical goods, here the “product” is the company’s future value, not just the current price.

Fundamental analysts believe:

• When growth prospects are high, demand increases, pushing prices up.
• When outlooks are poor, supply or selling pressure increases, pushing prices down.

Technical traders also analyze demand and supply through various tools:

Tool 1: Candlestick Patterns and Price Action

Green candles (close > open) indicate strong buying during that period. Red candles (close < open) show selling pressure.

Doji candles (open ≈ close) suggest indecision—buyers and sellers are balanced.

Tool 2: Trend Analysis

Higher highs and higher lows indicate an uptrend; lower lows and lower highs suggest a downtrend. Sideways movement shows indecision, waiting for a breakout.

Tool 3: Support and Resistance

• Support: Price levels where buyers tend to step in.
• Resistance: Price levels where sellers tend to emerge.

Breakouts above resistance or below support signal potential trend changes.

Demand and Supply Zones—When to Buy, When to Sell

Many traders use “Demand and Supply Zones,” which mark points where the market’s balance shifts.

Case 1: Sharp Drop (Drop) followed by a Base and Rally (DBR)

What happens? Heavy selling pushes prices down sharply. Once low enough, buyers see opportunity, but the battle between buyers and sellers remains unresolved, causing price to hover.

When to buy? If positive news or new factors emerge, demand surges, breaking above the previous high, signaling a buy opportunity.

Case 2: Rally (Rally) followed by a Base and Drop (RBD)

What happens? Buyers push prices up strongly, but once high, sellers see profit and start selling, causing a tug-of-war.

When to sell? If negative news or adverse factors appear, selling pressure increases, breaking below support, signaling a sell.

Case 3: Continuous Uptrend (RBR)

What happens? Buyers remain strong, and positive news keeps pushing prices higher.

Case 4: Continuous Downtrend (DBD)

What happens? Sellers dominate, and negative news drives prices lower.

The Bottom Line: Understanding Supply and Demand

The law of supply and demand is the core mechanism that drives prices across markets—commodities, stocks, or currencies.

If investors can predict shifts in supply and demand, they can better anticipate market movements.

However, mastering this requires practice—learning from real price action repeatedly helps you see the bigger picture and improve your investment decisions.