Supply Rules: Essential Knowledge for Traders and How to Apply Them in the Stock Market

In the world of investing and trading, no concept is as fundamental and useful as understanding demand and supply in explaining price movements. This economic principle is not just a theory sitting in textbooks; it is a driving mechanism that occurs in all financial markets, from stocks to commodities.

Basic Understanding: What Are Demand and Supply?

Demand and Supply are two sides of the same coin. Demand refers to the willingness to buy, while supply is the willingness to sell. When analyzing both together, it becomes clear that they create pressure on prices at each point in time.

Demand (Demand): Buying pressure in the market

Demand is the quantity of goods or services that buyers are willing to purchase at various price levels. When plotting the relationship between price and quantity, we get the (Demand Curve), where each point on the curve represents the quantity consumers want to buy at a specific price.

The basic law of demand states that there is an inverse relationship between price and the quantity demanded: higher prices → lower demand, lower prices → higher demand. This phenomenon is driven by two main factors:

Income Effect (Income Effect): When prices fall, buyers’ purchasing power increases, allowing them to buy more goods.

Substitution Effect (Substitution Effect): When the price of a good decreases, it becomes more attractive compared to other goods, leading buyers to substitute and buy more of the cheaper item.

Factors influencing demand levels are not limited to price alone; they include consumers’ income, prices of substitute goods, tastes, the number of buyers in the market, and expectations about future prices. External factors such as seasonal changes, government policies, and consumer confidence also have an impact.

Supply (Supply): Waiting to sell pressure

Supply refers to the quantity of goods or services that sellers are willing to offer at various price levels. Plotting the relationship between price and quantity yields the (Supply Curve), where each point indicates the quantity sellers are willing to supply at a given price.

The law of supply, which is central to this study, states that there is a direct relationship between price and the quantity supplied: higher prices → more willingness to sell, lower prices → less willingness to sell. This can be clearly observed in real markets: when stock prices rise, shareholders who profit from gains are more willing to sell; when prices fall, sellers may hold back or wait for prices to recover.

Factors affecting overall supply include production costs, prices of alternative goods, the number of sellers, technology, future price expectations, weather and natural disasters, tax policies, exchange rates, and access to funding.

Equilibrium (Equilibrium): Where prices stop changing

When demand and supply meet, an (Equilibrium) point is established, where the demand and supply curves intersect. At this point, prices and quantities tend to stabilize because both parties are satisfied.

If the price is above the equilibrium point, sellers will produce and sell more, while buyers will purchase less, leading to excess supply and a downward pressure on price back to equilibrium. Conversely, if the price is below equilibrium, buyers will want to buy more, while sellers will reduce supply, resulting in a shortage and upward pressure on price to return to equilibrium.

Application in Financial Markets: Influential Factors

Financial markets are more complex than typical goods markets; asset prices such as stocks are driven by many factors.

Demand Drivers in Financial Markets

Macroeconomic factors influence investment demand: low interest rates encourage investors to seek higher returns in stocks; economic growth and sustained inflation also increase willingness to invest.

Market liquidity: the more money circulating in the system, the more investors tend to seek risky assets. High liquidity increases demand.

Investor confidence: acts as motivation to buy or sell. Expectations about earnings, company growth, or economic and political stability all influence investment decisions.

Supply Influences in Financial Markets

Decisions of listed companies directly affect supply: share buybacks reduce the number of shares in circulation, while capital increases add shares.

Entry of new companies via IPOs introduces additional securities to the market, which can impact prices in the short term.

Regulations and rules influence the ability to offer securities: conditions like the Silent Period restrict major shareholders from selling shares immediately after IPO.

Methods: Demand and Supply in Stock Price Analysis

Traders and analysts use demand and supply concepts mainly in two ways:

Fundamental Analysis (Fundamental Analysis)

Stock prices are not just representations of the stock itself but reflect the demand for investing in the business (Market Cap). When fundamental factors change, demand and supply shift accordingly.

If earnings forecasts are positive, buyers are willing to pay higher prices or buy in larger quantities. Sellers may hold back, causing prices to rise. Conversely, negative data causes buyers to delay entry and sellers to prepare for selling, leading to price declines.

Technical Analysis (Technical Analysis)

Traders utilize demand and supply in the form of buying and selling pressures, measured with more precise tools.

Price Action and Candlestick Patterns (Candlestick): Green candles (close higher than open) indicate strong demand, while red candles (close lower than open) indicate strong supply. Doji (open-close near the same level) suggests a battle between the two sides.

Price Trends (Market Trend): Making higher highs indicates demand dominance, while lower lows suggest supply dominance. Range-bound prices show conflicting forces.

Support & Resistance (Support & Resistance): Support levels are where demand is waiting to buy, resistance levels are where supply is waiting to sell.

Demand Supply Zone Technique: Trading Application

Traders use the Demand Supply Zone technique to identify trading opportunities by spotting points where price loses balance and reverts to equilibrium.

Reversal Trading (Reversal)

Demand Zone Drop Base Rally (DBR): Price drops rapidly (Drop) from excess supply, then consolidates in a range (Base). When buying pressure returns strongly and breaks above the range, the price swings upward (Rally). Traders enter short positions at the breakout point.

Supply Zone Rally Base Drop (RBD): Price rises quickly (Rally) from excess demand, consolidates (Base), then when selling pressure dominates, it breaks below the range and declines (Drop). Traders enter short positions at the breakdown point.

Trend Following (Continuation)

Demand Zone Rally Base Rally (RBR): Price rises (Rally) to new highs, consolidates (Base), then when buying strength resumes, it breaks above the resistance of the range and continues upward (Rally).

Supply Zone Drop Base Drop (DBD): Price drops (Drop) from strong supply, consolidates (Base), then when selling pressure returns, it breaks below support and continues downward (Drop).

Summary

Demand and supply are not concepts only for economists; they are mechanisms that traders and investors must recognize and apply. Understanding which behaviors follow the law of supply and how demand influences ongoing investment is the foundation of accurate price analysis. Continuous study, observation, testing, and learning from real markets are essential.