Perhaps one of the most important aspects of Forex trading is understanding supply and demand. These two terms will become your foundation as you begin to build an arsenal of trading strategies such as the pin bar and inside bar.
While certain topics in the world of Forex may be optional depending on your style of trading, your ability to properly identify areas of increased supply and demand is paramount to your trading success.
By the end of this lesson you will be able to define these two terms, why areas of increased supply and demand form as well as how to identify them to assist you on your journey to consistent profits.
Supply and Demand Explained
When explaining any new term, I always like to start with a simple definition. This definition is so simple in fact that one word can be used to describe each term.
Supply = selling
Demand = buying
Of course it isn’t quite that simple, but that’s the general idea. An area of increased supply refers to an area of increased selling pressure. This selling pressure causes a market’s price to fall.
The chart below shows a simple supply curve.
Notice how in the image above, as the price increases so does the number of units available. This is because as a market increases in price, participants find it more appealing to sell which in turn drives prices even lower.
On the other end of the spectrum is demand. An increase in demand refers to an area of increased buying pressure. In other words, an area of support. This area of increased buying pressure causes a market’s price to rise.
The chart below shows a simple demand curve.
Notice how in the image above, as the price increases the number of units available decreases. This occurs due to buyers stepping up and driving the market higher which in turn reduces the number of units available to other market participants.
The ever-changing balance between supply and demand is what causes a market’s price to fluctuate over time. As supply increases a market will decline while an increase in demand will trigger a rally back the other way.
Now that you have a good understanding of the two terms, it’s time to learn how to identify these areas on a price chart.
How to Identify Areas of Value
The most effective way to go about translating the concepts of supply and demand into actionable areas on your chart is to change the way you think about the two terms.
At the end of the day, an increase in demand is just another way of calling attention to an area of support. In the same way an area of supply can be thought of as an area of resistance.
We call these support and resistance levels. These are the levels that form on your chart from which you want to look for buying and selling opportunities.
The chart below is a great example of how support and resistance can be used to your advantage.
Notice in the chart above we have a key horizontal level that has formed due to tension between buyers and sellers. The level starts out acting as resistance (supply) and later begins acting as support (demand) after the market breaks to the upside.
These levels, or areas of value can also form at a diagonal. We call the diagonal levels trend lines. These can also be a great way to identify buying and selling opportunities at value.
The chart above shows a strong level of demand that has been carved out by an impressive rally in GBPUSD. Notice how each time the market reaches this level, buyers step up and drive the market even higher.
Areas such as the trend line above can be a great way to identify potential turning points in a market. Key levels like this are extremely advantageous for traders and are therefore considered the foundation for any good Forex trading strategy.
Knowing how Forex supply and demand play a role in the market is extremely important to your trading success. It starts with understanding the concepts but the real value is knowing how to identify areas of value so you can begin capitalizing on them.