Supply and Demand absolutely everybody is talking about it. Including this hedge fund manager who explains exactly how he uses it in an interview. But we’ll get to that in a little bit. But why should we learn supply and demand in the first place? To understand that, we have to dive deeper into the core concepts of why the market moves.
The Basics of Market Movement
Why does the market move in the way that it does? Now I want you to think about this. The only way a chart will move up is if there is more buying pressure than selling pressure. The only way a chart will move down is if there is more selling pressure than buying pressure. Now I know what you’re thinking. Oh tradinglab that is so obvious. Why are you wasting our time and even telling us this? Because a lot of people don’t sit down and think about the basics. A lot of people will watch a YouTube video, and get told to draw some fancy rectangle on their chart by a random trading guru because they say it works, but in reality, the viewer has no idea why it works. They are just doing it because they are told it works. But not my viewers! You guys are smart. You want to learn.
Analyzing Market Participants
So look at this picture. Here we have all the buyers and sellers in the market. The red represents the seller’s winning. The green represents the buyer’s winning. When you have a ton of sellers, like in this area, the price will drop fast and sharp. Something like this. Because sellers are in complete control. As the price starts to go down, more and more buyers will start to fight against the sellers, slowly gaining back control. Now as more and more buyers are entering, this can cause little pullbacks on the chart. But the chart’s momentum is still overall bearish. Price will only fully reverse once there is a large majority of buyers compared to sellers. Like in this area. And once this happens, there will be a fast sharp move to the upside. Then the whole process repeats itself, going on forever in the future.
Insights from a Hedge Fund Manager
But we are just scratching the surface of how the market moves. You see, one day I got bored and read a financial article. Yeah, I know. I read financial articles when I’m bored. I’m a nerd. Anyway, I was reading an article that interviewed a hedge fund manager and how he looks at the market. So when reading this financial article, this hedge fund manager said something that stuck out to me: you need to focus on who is on the other side of the trade. Whenever you buy a position, there is always a seller on the other side of that trade. This means, there is always someone who thinks the chart is going to go in the opposite direction than what you think.
The Importance of Understanding Market Dynamics
Now this is a very, VERY important concept to understand. If you are always buying from someone who is selling, would you rather buy from a good trader or a bad trader? When you are buying a position, you want to be buying from someone who is inconsistently profitable. If you start thinking like this when trading, it will change the way you take trades. If you don’t know where these profitable traders are selling, you might just be one of those bad traders they are selling to.
Identifying Supply and Demand Areas
But how do you know where these profitable traders are buying and selling? Going back to this chart. The only way we know a large group of sellers or buyers are in complete control is if there is a sharp move. So take this chart for instance. When I look at this chart, I’m not trying to predict the future. I’m just looking at where the majority of buyers and sellers are. Here, the chart had a sharp downward move from this point, meaning there were way more sellers than buyers from this point on. In other words, an area of supply. You may ask, how do we know there are more sellers? If there weren’t drastically more sellers at this point, the price would just continue to move sideways here. But that didn’t happen. It moves sharply to the downside. Here the opposite is true; there was a sharp move to the upside, meaning there were way more buyers than sellers or an area of demand.
A Real-World Analogy
Another way to look at this is like this: You know the company Costco? Ahhh, I love that company. You can buy anything from there. But what is Costco’s business plan? They buy a large amount of inventory in bulk at a cheap price. Then what do they do? They sell it to a retail buyer for a higher price. The only way Costco can make money is if they sell to a quote-unquote bad buyer or someone willing to pay more than what they did for the product. You should look at trading the same way. If you’re Costco, where are you buying your inventory in bulk? Obviously at a low price. Where are you selling to the retail buyer? At a high price. Now remember that statement I made before? To be a winning trader, you have to sell to a losing trader. When you look at this chart, where will the losing trader be buying most likely? A lot of retail traders will buy in this area, maybe because they see some momentum building up, an indicator telling them to enter, or whatever the reasoning is. But they are missing a very important key point. Supply exceeds demand in this area, meaning there are drastically more sellers than buyers here. Only a bad trader would buy when there are more sellers. So when looking at this chart, you should be asking yourself two questions: Where are the major points where there are drastically more buyers and sellers? And where are the bad traders buying and selling? If you answer these two questions correctly, you will be a profitable trader.
Analyzing Buyer and Seller Dynamics
So where are the majority of buyers and sellers? Well, we can see from this point on, there was a sharp move to the upside. This could only happen if there were drastically more buyers than sellers. So we mark the beginning of this move. Where are there more sellers than buyers? Here we have a sharp downward move, which could only happen if there were more sellers than buyers. So we mark the beginning of this move. I want to make this very, very clear. The only reason these areas are supply and demand is because this was the beginning of a sharp move. If the chart looks something like this, we don’t have a clear area of supply and demand because there are no sharp movements. Sure, the chart moves down from this area, but that just shows there are slightly more sellers than buyers, which we are not really interested in. We want to know areas where there are drastically more sellers than buyers, which we can only tell if there is a drastic, sharp move. Please take note of this, because it’s very important.
Final Considerations for Trading
Then we have to ask the final question: Where are the bad traders most likely to enter and exit? A bad trader is going to sell when there are more buyers than sellers. So we have our supply and demand areas. Wait for the price to come to our demand. We buy from the retail trader who is inconsistently profitable. Set our stop loss below the area of demand. Set our take profit at the area of supply. Watch the trade play out. Price eventually hits the area of supply, and we sell to the inconsistently profitable trader who buys up here. So whenever you take a trade, ask yourself the two simple questions: Where are major points where there are drastically more buyers and sellers? And where are the bad traders buying and selling? If you answer these questions correctly, you will become a profitable trader.
Conclusion and Additional Tips
Since you made it this far in the video, here are two extra tips to make your supply and demand zones even stronger. So here’s a final recap of the perfect supply and demand trade. Here we have a strong move to the upside starting from this candle, so we mark our demand zone. Notice how there is also a fair value gap connected to this demand zone, giving us insight that there are more buyers than sellers in this area. We wait for the price to see what it does next. A similar thing happens up here. Price is starting to reverse with a strong downward move. This is our area of supply. This move also has a fair value gap connected to it as well, which shows there are a lot more sellers than buyers up in this area. Perfect. Next, we want price to slowly come down to our area of demand, slowly being the keyword. Once it hits our zone, we enter. Set our stop loss below the area of demand and set our take profit at the area of supply. And just like that, you got a winning trade. Start looking for areas where bad traders are buying and selling, and it will change the way you trade forever.
