How do stock prices fluctuate: What are demand and supply in investment decisions

If you’ve ever wondered why stock prices rise today and fall tomorrow, the answer lies in the basic economic concept called “Supply and Demand.” This idea isn’t just an abstract theory for academics; it’s the mechanism that drives the prices of all assets in the real-world financial markets. Investors who understand this fundamental will be better at reading the market and making smarter buy-sell decisions.

Price Drivers: Understanding Supply and Demand

Buy and sell demands—these are the core of price determination. Prices don’t randomly drift away; they are formed through the interaction between buyers and sellers seeking equilibrium. Understanding the difference between supply and demand is a crucial skill for anyone looking to profit from the stock market.

Many investment problems arise because investors only see the price numbers but don’t understand what drives those movements. The answer is in analyzing supply and demand.

Demand: The Buying Force That Pushes Prices Up

Demand is the willingness of consumers—in this case, investors and traders—to buy assets at various prices. When investors see a company’s growth potential, they are ready to buy. If the price drops, demand often increases because more people see it as a good value.

For investors, demand is reflected in increased purchase volume, showing how strong the buying interest is. Factors influencing overall demand include:

• Company Performance: Better-than-expected earnings excite consumers and boost buying.
• Economic Outlook: In a healthy economy, people are more confident to invest.
• Interest Rates: When rates are low, investors tend to seek higher returns in stocks.
• Market Sentiment: When the market is bullish, demand surges.

The law of demand states that as prices rise, the quantity demanded decreases; as prices fall, demand increases—this is very logical.

Supply: The Quantity of Assets Available for Sale

Supply is the amount of stock that shareholders and market makers are willing to sell. In stock markets, supply is determined by the number of listed shares and the decisions of shareholders whether to sell or hold.

For listed companies, supply may increase when:

• New Shares Are Issued: Capital increases or IPOs add more shares to the market.
• Major Shareholders Sell: Executives or large shareholders decide to divest.
• No Positive News: When there’s no new good news, sellers may want to offload holdings.

Other factors affecting supply include:

• Production and Distribution Costs: Higher costs may discourage selling at low prices.
• Prices of Related Goods: Sellers compare and adjust prices based on market conditions.
• Number of Sellers: More competitors mean higher supply.

Supply law is opposite to demand: as prices go up, sellers tend to sell more; as prices go down, they may hold back or wait for better opportunities.

Equilibrium: The Meeting Point of Supply and Demand

Market prices are not determined by demand or supply alone but by their intersection. The equilibrium point is where the quantity buyers want equals the quantity sellers want, and transactions occur.

If the price exceeds equilibrium, a “surplus” occurs—more sellers want to sell than buyers want to buy—pushing prices down. Conversely, if the price drops below equilibrium, a “shortage” occurs—more buyers want to buy than sellers want to sell—pushing prices up.

Markets tend to oscillate around this equilibrium, unless driven by major news or fundamental changes.

Buying and Selling Forces: The Demand and Supply That Investors Must Know

Understanding the reasons behind changes in supply and demand is vital because financial markets are driven by more complex factors than commodity markets.

Common Factors Affecting Demand in Financial Markets

Macroeconomic Factors influence investor behavior worldwide. When interest rates are low, borrowing is cheaper, and investors are more willing to allocate funds into stocks rather than savings accounts.

Liquidity: The amount of money flowing into the system. When central banks inject liquidity, investors have more capital to invest, often leading to rising markets.

Investor Confidence: Based on their outlook, if investors see strong growth prospects, they are eager to buy now. If they fear overvaluation, they may hold back.

Common Factors Affecting Supply in Financial Markets

Corporate Policies: Buybacks reduce outstanding shares, decreasing supply, while issuing new shares increases it.

New Market Entries: IPOs introduce new shares, which can temporarily pressure prices downward.

Regulations: Rules like “Silent Periods” after IPOs limit selling, affecting supply dynamics.

Other factors include:

• Production and Distribution Costs: Higher costs may limit supply.
• Prices of Related Assets: Sellers compare prices and adjust accordingly.
• Number of Sellers: More sellers increase supply.

Supply law states that as prices rise, sellers are more willing to sell; as prices fall, they may wait or hold back.

From Theory to Market: Applying Supply and Demand to Real Price Analysis

The theory is useful, but investors need to know how to apply it. Fundamental analysis and technical analysis both rely on supply and demand concepts.

Reading Signals from Candlestick Charts

In trading, “Price Action” analysis uses candlestick patterns to observe buying and selling pressures.

• Green Candles (close higher than open) indicate buying dominance; demand is strong, and prices tend to rise.
• Red Candles (close lower than open) show selling dominance; supply is strong, and prices tend to fall.
• Doji Candles (open and close at the same level) suggest indecision; neither side has gained the upper hand.

Tracking Trends and Reversals

Professional traders use “Market Trends” to interpret supply and demand.

• Higher Highs and Higher Lows: Indicate strong buying interest; demand dominates.
• Lower Lows and Lower Highs: Signal strong supply; sellers are in control.
• Failure to Make New Highs: Could be a warning that demand is weakening.

Support & Resistance Levels

• Resistance: Price level with abundant supply—sellers eager to offload holdings.
• Support: Price level with abundant demand—buyers waiting to purchase at a perceived fair value.

These levels help traders visualize supply and demand zones.

Demand and Supply Zones: Timing Entries and Exits

A popular application is identifying Demand and Supply Zones, areas where price previously paused or reversed.

Reversal Trading (Demand Zone Drop Base Rally - DBR)

Imagine a sharp decline (Drop), followed by a consolidation (Base), then a rally. This pattern indicates:

• Excess supply pushed prices down.
• Buyers see value at the low.
• New positive news or sentiment causes demand to surge.
• Price rebounds sharply.

Traders may buy when price breaks above the Base.

Continuation Trading (Demand Zone Rally Base Rally - RBR)

In this pattern, prices rally, consolidate, then rally again, showing:

• Strong demand.
• Some sellers take profits, causing a pause.
• Demand remains dominant, pushing prices higher.

Buyers can enter during the Base for a better entry point.

Supply Zone Reversal (Supply Zone Rally Base Drop - RBD)

Here, prices rally, consolidate, then drop:

• Excess demand leads to overbuying.
• Sellers step in at high levels.
• New selling pressure causes price to fall.

Traders may short at the break of the Base.

Downward Supply Zone (Drop Base Drop - DBD)

Sometimes, prices fall, consolidate, then fall again, indicating:

• Persistent selling pressure.
• Supply remains high.
• Prices tend to decline further.

Traders might follow the trend with caution, setting stops appropriately.

How to Assess Supply and Demand in Real Life

1. Fundamental Analysis

Long-term investors focus on fundamentals—the core drivers of demand.

Good earnings, positive outlooks increase demand, raising prices.

Negative news, scandals, or poor performance decrease demand, causing prices to fall.

2. Technical Analysis

Traders focus on short-term supply and demand, visible in support/resistance levels and trendlines.

They use Price Action and volume to gauge current buying and selling strength, regardless of company fundamentals.

3. Monitoring Volume

Volume is a key indicator.

• Rising prices with low volume may suggest weak demand.
• Rising prices with high volume indicate strong demand and more sustainable moves.

Summary

What is supply and demand? Simply put, it’s the fundamental force that determines asset prices. When demand exceeds supply, prices go up; when supply exceeds demand, prices go down.

For investors, understanding supply and demand isn’t difficult, but applying it to real market data is key. Whether you’re a long-term investor analyzing fundamentals or a short-term trader reading candlesticks, the core idea remains: you’re trying to read what the market is doing, what people want, and where it’s headed next.

Success comes from continuous study, experimentation, and adaptation. The more you observe and understand supply and demand in real markets, the better you’ll become at reading the market.