Understanding the laws of supply and demand and their application in stock trading

Price forecasting in the financial markets is not just about looking at numbers and trends, but about understanding the behavior of buyers and sellers. All of what drives this is the law of demand, which is based on economic principles but can be effectively applied in trading markets.

Demand and Willingness to Pay

(Demand) describes the desire of buyers at various price levels. It does not just mean wanting to buy, but encompasses the relationship between the quantity consumers are willing to purchase and the price they are willing to pay.

When prices decrease, the demand quantity increases due to two fundamental reasons:

Income Effect: When goods become cheaper, your real purchasing power increases, allowing you to buy more with the same amount of money.

Substitution Effect: Lower prices make this product more attractive compared to alternatives, prompting buyers to choose this product instead.

Other factors influencing demand include consumer income, tastes, the number of buyers, future price expectations, and even seasonal or current trend factors.

Supply and Its Relationship with Price

(Supply) explains the quantity of goods sellers are willing to offer at various prices. Unlike demand, which has an inverse relationship, supply is directly related to price.

As prices rise, sellers are motivated to supply more because of higher profits. Conversely, when prices fall, sellers tend to reduce supply because profits are less attractive.

The law of supply is influenced by production costs, prices of substitute goods, the number of sellers, technology, climate conditions, and tax policies.

Equilibrium: Where Buyers and Sellers Meet

The actual market price is not determined solely by demand or supply but occurs at the point where the demand and supply curves intersect, called equilibrium (Equilibrium).

At this point, the quantity demanded by buyers equals the quantity supplied by sellers, and prices tend to stabilize.

If prices are above equilibrium, sellers want to sell more, but buyers will buy less, leading to excess (Surplus), which pressures prices downward.

If prices are below equilibrium, demand increases while supply decreases, leading to a shortage (Shortage), which pushes prices upward.

The Mechanism of the Law of Demand in Financial Markets

Financial assets, such as stocks, differ from commodities in that their demand reflects opinions about future value, not just consumption needs.

###Factors Driving Demand in the Stock Market

Macroeconomic conditions such as economic growth, inflation rates, and interest rates directly affect investment demand. When interest rates are low, investors seek higher returns and often flock to the stock market.

Liquidity in the financial system: An increase in money flow within the financial system provides more cash for investment, boosting demand for risky assets.

Market confidence: Expectations about the future of companies, the economy, and political situations significantly influence investor decisions.

###Factors Driving Supply of Securities

Corporate financing policies: Capital increases, share buybacks, or issuing new securities all impact supply.

Entry of new companies: IPOs increase the number of securities available in the market.

Regulations and policies: Stock exchange policies and regulatory frameworks affect the ability to issue securities.

Application in Technical Analysis

Traders use the law of demand to interpret signals on price charts.

Reading candlesticks: Green candles (close higher than open) indicate buying strength; red candles (close lower than open) indicate selling strength; doji candles (open and close near each other) show indecision.

Trend analysis: Making new highs suggests strong demand; making new lows indicates strong supply; horizontal prices show balance.

Support and resistance: Support zones are areas with increased buying pressure; resistance zones are areas with selling pressure. Breaking these levels indicates major shifts in equilibrium.

Timing with Demand Supply Zone

The Demand Supply Zone technique involves identifying zones of excess demand or supply, then waiting for price to revisit these zones.

Demand zone (DBR - Drop Base Rally) occurs after a price drop (Drop), followed by consolidation (Base), then a rally (Rally). Traders buy at breakout points of the base with stop-losses below.

Supply zone (RBD - Rally Base Drop) occurs after an upward move (Rally), consolidation (Base), then a drop (Drop). Traders sell at breakout points with stop-losses above.

Trend continuation often occurs more frequently than reversals, as demand or supply in the existing trend reasserts itself after a brief pause, causing prices to continue in the same direction.

Summary

The law of demand is a fundamental force that determines prices and trading volumes in markets, whether for commodities, stocks, or other financial markets.

Understanding the relationship between demand, supply, and equilibrium helps investors and traders forecast price trends more accurately. Applying this concept alongside technical tools like candlestick analysis and support/resistance levels enhances decision-making and risk management.

Most importantly, studying and practicing the application of these ideas with real market data helps develop a clear understanding of demand and supply behaviors.