Supply and Demand Trading

[Zack Zarr 5]

Supply and Demand – The Only Force

 

As I mentioned in my previous posts, the only force that moves the value (or price) of anything in our lives is the Supply and Demand.

 

Do a quick google search on Supply and Demand Trading right now, and I bet you would be reading pages and pages of useful materials on the internet. This is not a secret methodology of trading that I, or any trader alive have discovered very recently. This is a concept that people have been aware of for centuries.

 

How to use Supply and Demand in our daily trading?

 

If you have read my book and the previous post, you might have some hints about this type of trading. Without getting into the basics, I want to clarify one important concept.

 

YOU and I and perhaps every retail trader like us, DO NOT create the Supply and Demand in the forex market. We have no impact in the overall picture of the market for that matter. You might argue that is not 100% true, and you could be right. I believe that in a marketplace where the average daily turnover is about $4 trillion (according to the Bank of International Settlements, BIS) in April 2013 and $5.3 trillion based on BIS report in 2014, it is extremely unlikely that a retail trader can have any impact in such a daily volume. About 90% of this daily volume is controlled by the large financial institutions such as asset managements and hedge funds.

 

Side Note: About 75% of this trading volume is conducted in the G10 currency pairs, i.e. the major pairs you can all name as the usual suspects.

 

Side Note: Check out the daily size of the stock markets in North America and across the world (here, here and here) to get some perspective of the forex market size.

 

Back to Supply and Demand Trading: key point that many traders forget when following the Supply and Demand methodology, or Supply and Demand traders, is that identifying a supply and demand “zone” is not something that is done mechanically.

 

Note: I hope you have read about the “zone” either in the book or other online sources. The supply or demand occurs within a zone, or a range, rather than a single level (such as support and resistance)

 

It is important to realize that highlighting an area off a big body candle does not always tell the whole story. Such large candles do indicate the presence of an “imbalance” between the buyers and sellers. However, does that mean we can use a zone to place trade in our advantage? Yes and No.

 

Yes, because you can always count on the massive amount of orders being left “unfilled” during the creation of a big body candle. See the image below as an example:

 

 

You would place a short somewhere near the supply zone based on the red big body candle, and yes you would have made good profit from it. But how about the two other big candles on its left? How about a long order based on the blue candle?

 

These are all questions that come up in your daily forex trading life. And I can tell you that there is no certain answer to any of these questions. The forex trading is the game of probabilities. You place your orders based on the statistical data you have in your hand. So, the more data you have, the better you can evaluate the probability.

 

The chart has it all!

 

As I have mentioned before, the chart is your first source of information. The fact that a big move from a certain level has happened in the near past, does mean that some institutional orders have been placed in the marketplace. We can certainly benefit from these unfilled orders next time the price reaches such levels. But how far? Have a look at the same chart from a different perspective, i.e. a higher time frame:

 

 

Think about what happened over the time period indicated by the red box in this image. The box resembles the exact area that was shown in the previous image. Do you see what happened? In this chart, you only see three giant blue candles. Think of them as the "dinosaur’s footprints" as they moved across the forest. These are “smart” dinosaurs. They created that area shown in the box only to place their foot one step ahead.

 

To put all these in perspective, do not underestimate the power of multiple timeframe (TF) analysis. Also, do not overanalyze, 3 TFs is enough to give you the overall theme.

 

I also mentioned “more data” is always good. By that, I DO NOT mean adding more indicators to your chart. I meant looking at the actual footage of the institutional orders. More of this concept will come in the next posts.

 

Zack