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Most traders depend on technical indicators to identify imbalances in the financial markets. The technical indicators provide insight into market momentum and help determine prices. Likewise, other traders closely watch key levels in price action where most actions tend to occur, leading to sharp price movements. Supply and Demand zones are crucial price levels created by banks and other large institutions from where big trends emerge.
Supply and demand zones refer to areas in a price chart where the price regularly approaches. They are areas of intense battles between buyers and sellers and often result in the form of consolidation, after which price break out.
Supply, also called the distribution zone, is an area in a price chart where traders look to sell the market. The zone mainly occurs when the price has moved up significantly, presenting an opportunity for large institutions and retail traders to sell high. Given that the zone is present above the current price level, it presents the highest selling interest or potential.
The chart above shows the AUDJPY price action chart. Initially, the currency pair was in a downtrend before it bounced back and started edging higher. However, the bounce back appears to have hit a strong supply zone whereby buyers struggled to push the price higher.
Given that the supply zone is an area of strong selling pressure characterized by large institutions placing large sell orders, price struggle to rise further. Consequently, it acts as an area of strong resistance where sellers flock to the market and place sell orders to push prices lower.
Depending on the number and size of sell orders placed in the supply zone, the price will always get rejected and move lower every time it bounces to this level. Prices will only rise above the supply zone where buyers overpower sellers and place more buy orders.
The demand zone is also the accumulation zone that occurs below the current price level. The area is characterized by strong buying interest or potential as large institutions tend to place more buying orders to try and buy low.
Consequently, the demand zone acts as a strong support level whereby sellers struggle to push prices lower under buyers' pilling pressure.
In the AUDJPY price chart above, it is clear that the price was initially in an uptrend with bulls in control. Every time the price pulled back into the demand zone, it bounced back, with sellers struggling to engineer any move lower. The seller's failure to push the price lower signaled that the area was well defended by large institutions that had initially placed buy orders to push the price higher.
As long as the large institutions defend this level with buy orders, the likelihood of price plunging below is minimal. Consequently, retail traders use this opportunity to enter long positions every time the price pulls back to the demand or accumulation zone.
The first step to identifying supply and demand zones entails looking at the price chart and identifying areas where strong price movements occurred. The sharp price movement should result in prices moving in one direction with minimal or no opposition.
Once the strong price movement is identified, look for the level at which the strong price movement started. The level at which the sharp movement started will often be a crucial supply and demand zone deepening on the direction price moved.
For instance, if the price ended up moving lower, the supply zone would be the highest level at which the movement started. On the other hand, if the price exploded, making higher highs, the demand zone would be the lowest level at which the movement began.
The best way to find a supply and demand zone is to use longer timeframes to identify areas where strong consolidation occurs. Four-hours, daily, and weekly charts provide a clear view of potential supply and demand areas. While in the longer timeframes, it is essential to use rectangular shapes to denote this zone that should act as support and resistance levels.
In addition, always be on the look for strong moves out of potential supply and demand zones. Any sharp move signifies strong momentum in the new direction, affirming the initial buildup in momentum from large institutions placing orders. Price will always move sharply from the supply and demand zone until the value has diminished or the large institutions achieve their objective.
The use of indicators can also come into play to identify potential areas of distribution and accumulation. For instance, a moving average will often flatten whenever the price enters a period of consolidation due to accumulation and distribution in the market.
The Fibonacci indicator is another vital technical analysis tool that can help one pinpoint supply and demand zones. Given that price does not always move in one direction, pullbacks and bouncebacks often lead prices to key supply and demand areas.
For instance, if the price was moving lower only to bounce back after hitting a support level, the likelihood of it bouncing back to the supply zone is usually high. With the help of the Fibonacci tool, one can identify the supply zone. Plotting the Fibonacci tool from where the downtrend started to where the price started bouncing back makes it easy to identify the supply zone at the 61.8% retracement level.
The 61.8% level is considered a significant level where consolidation occurs, thus acting as a crucial supply and demand level.
While an influx of sell orders characterizes the supply zone as sellers look to sell high, traders can look to enter sell positions in anticipation of the price edging lower afterward. Therefore, while placing a sell order below the supply zone, it is essential to place a stop-loss order a few pips above the zone. The stop-loss order will close the sell order should the price fail to edge lower after consolidation from the supply zone.
Likewise, one can look to enter buy orders near the demand zone, given that an influx of buy orders characterizes the area. The prospect of the price edging higher from the demand zone is usually high. Stop loss orders should be placed a few pips below the demand zone. This will close down any buy positions once the price fails to move up above the demand zone and starts moving lower.
Trading supply and demand zones boil down to the unique patterns at these levels. Below are some of the best strategies for trading supply and demand zones in forex.
Considering the consolidation in the demand and supply zones, a range trading strategy can be used with some success. With range trading, traders can look to sell on price approaching the supply zone, which acts as a level of intense selling pressure. Given that large institutions are increasingly placing short positions at this level, a retail trader can place a sell position in anticipation of a price dropping.
Likewise, one can look to enter a buy position as soon as the price drops to the demand zone, which is a zone characterized by intense buying pressure. Given the growing number of institutions placing buy positions, one can place a buy position anticipating the price bottoming out and moving up.
A breakout strategy is another vital strategy for taking advantage of the forex supply and demand zone. The price can never remain restricted in a given trading range in the forex market. Once in a while, it breaks out on a buildup of momentum in a given direction.
Similarly, one can leverage the Stochastic indicator, a momentum indicator, to know when to enter a sell position in the distribution zone and buy positions in the demand zone. For starters, whenever the stochastic reading exceeds 80, it implies overbought conditions, and the prospect of price reversing course from the supply zone is usually high. Therefore, it is an ideal level to go short. Similarly, if the RSI reading is below 20, it implies oversold conditions, which are ideal conditions for placing buy positions in anticipation of the price bouncing back.
For instance, after long periods of consolidation in the supply zone, the price would eventually break out and edge lower on short sellers placing significant sell orders. If selling pressure is enough, the price will edge lower.
Likewise, in the demand zone, price is often expected to break out to the upside with large institutions using the opportunity to place buy orders resulting in a buildup in bullish momentum. Consequently, a trader can look to enter a buy trade to profit from the price breaking out of the accumulation zone and moving up.
The price usually moves in a predetermined direction based on supply and demand zones. For instance, instead of the price moving up from the demand zone. It might end up edging lower on buyers failing to place significant buy orders to counter the selling pressure from the supply zone.
In the chart above, it is clear that the price ended up breaking out to the downside from the demand zone. Confirming intense selling pressure from the supply zone
Mastering how to find supply and demand zones is one of the best ways of gaining an edge in forex trading. Given the consolidation, these zones are vital price action levels from where big trends start. If it is a supply zone, the prospect of price plunging afterward is usually high as large institutions place sell orders. Similarly, if it is a demand zone, the prospect of price exploding and moving up is usually high on large institutions placing buy orders.