Supply and demand are the drivers of price in any free market. These zones exist because traders aim to purchase currency pairs when they are low in value and sell when they are high. The zones are not static, they change based on market conditions, fundamental factors and traders’ decisions.
Most people believe that currency pair price increase because buy contracts exceed selling, which is not true. In trading, buying always equals selling. Otherwise, the contract would not be filled. We’ll expand this topic in this guide and discuss FX trading supply and demand strategy.
The supply and demand strategy in fx trading, or SD for short, is a relatively simple approach that is often incorporated into a broader trading strategies.
Core features of a supply and demand strategy
- The supply and demand strategy in fx trading uses supply and demand zones to spot entry prices for traders
- Traders use stop loss and take profit orders based on those areas to mitigate downside risk
- Indicators, such as the RSI, volume indicators and MACD are most frequently used in Forex supply and demand strategy
- Longer time frames are used to identify supply and demand zones
- While all traders can use the SD strategy, leveraged traders using mini and standard lots can get the most out of it
- Supply and demand strategy fx traders use, focuses on areas where massive selling and massive buying occurs to spot significant areas
How does the supply and demand strategy work in forex trading?
The SD strategy revolves around identifying supply and demand zones that act as support and resistance points on a chart. Identifying these zones requires a combination of fundamental and technical analysis. Traders need to keep track of the market to anticipate major news releases that can affect the supply and demand of currencies, while also deploying technical indicators to outline the supply and demand zones more accurately.
How is price created?
As already mentioned, most people believe that price increases when buyers are more than sellers. Which is not true. Buyers always equal sellers. Let’s dive deep and understand how price is created and how’s that correlated with supply and demand. There are two types of orders: limit orders and market orders. When a trader places a market order, he/she enters a market at current prices in current time. Limit orders enable traders to buy or sell from predefined price areas, and they only get activated if price reaches that point. Now let’s see a price creation example. Let’s say there are limit orders that sell a security placed at 125.01(100 contracts), at 125.02(300 contracts) and at 125.03(500 contracts). And I decide to purchase 500 contracts using a market order. The platform will enable me to purchase 100, 300 and 100 contracts with respective values and the price of the security will jump to 125.03. As you can see, bought and sold contracts are always equal. The same is true in every market. It’s worth mentioning that FX is the largest market and retail orders usually get filled easily, however, understanding how prices move can help you incorporate FX trading supply and demand strategy.
Supply and demand zones
Supply and demand zones refer to the areas on the chart where traders sell or buy assets. This could be for a multitude of factors, such as:
- The asset reaching the desired price target
- Sudden economic changes prompt traders to alter their strategies
- News related to a specific asset changing market sentiment
Prices can be highly sensitive towards supply zones, which indicates an increased selling interest on the market. As for demand zones, many traders may not want to buy a security until it has reached their price target, which can cause sharp triggers on the market once it has been reached.
For example, the YTD chart of the GBP/USD pair shows the supply and demand zones since the start of 2022. A notable supply zone starting in September highlights the period during which the pound dropped to a historic low against the dollar and fell below 1.07.
To fall within these zones and execute trades to full effect, traders deploy stop-loss and take profit orders when using the supply and demand strategy.
To find supply and demand zones on a chart, traders can look for clues using a candlestick chart:
- To find a demand zone, look for a group of candles moving up and away from the prevailing range, which may signal a breakout due to high demand and increased buying interest
- To find a supply zone, look for the opposite – a group of candles that are moving down from the prevailing range, which may signal a breakout due to oversupply and increasing selling interest
Order types for the supply and demand strategy
Supply and demand strategy for fx traders is very similar to trading significant areas. Traders use various order types to trade them.
For entering the market, traders can use market and limit orders. Limit orders are more preferable, as they enable traders to enter from predetermined levels. Stop Loss orders are placed outside demand and supply zones, as you can see in the example below.
Range trading strategy
A subcategory of supply and demand strategies, range trading is the most simplistic approach to SD. Traders look for currency pairs with supply and demand zones that are easy to identify and enter as one zone ends. The primary focus of range trading is to trade against the previous zone once it has finished. Range trading is somewhat similar to support and resistance trading, but the supply and demand zones are typically wider.
Market sentiment changes all the time, which means that supply and demand zones have boundaries and substitute each other constantly. A breakout happens when either zone ends and the market shifts in the opposite direction. To spot the difference between a full-scale breakout and a false alarm, keep track of the trading volume. Prices will test the boundaries of a zone multiple times before a breakout happens.
Breakout strategies are logical continuations of range trading, as markets are constantly moving from one consolidation point to another. The more frequently price touches the supply/demand lines, the higher the likelihood of a breakout.
Other factors to consider
As mentioned earlier, supply and demand strategies use a combination of technical and fundamental analysis to determine the supply and demand zones on a price chart. On larger time frames, finding these key supply and demand zones depends on a range of economic factors and news releases that affect the decision-making of traders. Some of these factors are:
- Inflation and its effects on a particular currency
- GDP growth figures and economic forecasts
- Monetary policy and interest rates, which determine the rollover rates for traders
- Consumer data and economic opinion polls
- International politics and foreign affairs
- Knowledge of technical indicators, such as the relative strength index (RSI) and the moving average convergence/divergence (MACD) as well as volume indicators
All of these factors greatly impact the performance of individual currencies, which in turn, influences the price charts of forex pairs. Supply and demand zones can act as psychological boundaries and support/resistance points on a macro scale.
Pros and cons of supply and demand strategy in forex
The supply and demand strategy is an overall beneficial strategy to implement in the long run and is closely correlated with real-time economic data impacting the supply and demand of currencies.
- Predefined price levels allow traders to use the SD strategy without the need for constant monitoring
- Take profits and stop losses limit the downside risk
- The factors affecting the strategy are not vague or overly complicated
- SD can be a reliable and versatile strategy in the long run
- Supply and demand strategy works well with multiple indicators, such as the RSI and MACD
- Supply and demand is not a standalone strategy and works best when successfully integrated into strategies with a broader scope
- SD strategy Is most suitable for long time frames and may not be as effective in the short term
- The supply and demand strategy does require some usage of technical indicators, which may take some time to get used to for inexperienced traders
Example of a supply and demand strategy in forex trading
To better understand the SD, let’s look at the supply and demand strategy example. The image below shows the EUR/USD chart with supply and demand zones and the RSI indicator. Using them in combination can help test where significant breakouts have happened since the start of the year.
We can see that supply and demand zones are visible on the chart, and the RSI indicator also shows significant shifts in price momentum. The euro and the US dollar have been subject to much speculation throughout 2022 due to an uncertain political and economic climate on the world stage, rising inflation and recession fears. Political and economic announcements can shift supply and demand areas and make trading reactionary. Which is why it’s always recommended to technical traders to keep an eye on economic calendar. Price moves from significant zones to significant zones, and they can serve as entering and exiting markets.
FAQs regarding supply and demand strategy in forex
Does supply and demand strategy work in forex?
Supply and demand is a useful strategy to incorporate in the long run, as it is based on fundamental analysis and economic news, coupled with reliable technical indicators. The list includes: the relative strength index, volume indicators and moving average convergence/divergence.
What are the 3 main tips for supply and demand strategy?
Traders are advised to use long time frames, continuously monitor market sentiment and use technical indicators to identify supply and demand zones. The combination of market trends and momentum indicators makes for a well-balanced supply and demand strategy.
What is the main principle of supply and demand strategy?
The core principle of the supply and demand strategy is based on the simple economic principle of supply and demand changes determining market prices. High demand and low supply increases prices, and vice versa.