Supply and demand in Forex: a complete guide

This article will clearly explain what supply and demand mean in trading. We will discuss their role and how they can help you earn money in Forex.

What are supply and demand in Forex?

Supply is the amount of currency that's available for trading. Demand represents how much currency people are willing to purchase. If there's more demand, the price rises; on the contrary, when there's more supply in the market, the price decreases.

Let's see how the balance of supply and demand in Forex looks in the charts.

In this chart, the highlighted area is the demand zone: as demand grows larger than supply, the price starts rising.

Similarly, the supply zone forms at the local top after the market has been bullish for a while, causing the price to start decreasing. The chart below shows the supply area.

Why are supply and demand essential for trading?

The supply and demand strategy (also called S&D) taps into the very soul of Forex trading: the forces of supply and demand determine the price of one currency compared to another, and so taking them into account will significantly increase your trading game. If you are careful enough when identifying supply and demand, you can be in a good position to forecast how the market will react in the future.

Reasons why supply and demand are crucial for market analysis:

• They show market trends. When you look at how many people want to buy or sell a currency, you can see patterns in the market. For example, if a country is doing well financially, you can expect more people to buy its money. It means the price of that currency will probably increase in value.
• They help you make intelligent trades. Traders apply S&D to know when to buy or sell different currencies. If they notice that a currency is becoming popular (more people want it), they might buy it because they think its price will increase later. But if there's too much of that currency available and not enough buyers, they might sell it to avoid losing money.
• They reflect economic health. Supply and demand can also show how strong a country's economy is. If many people buy that country's currency, it usually means the economy is doing well.

Supply and demand example

Let's take the most basic currency trading pair, EURUSD. If the U.S. is doing well economically, the demand for the U.S. dollar will probably increase, exceeding supply and driving the price of the dollar up. On the other hand, if the U.S. Federal Reserve is issuing unfavourable press releases or the EU is suddenly on the rise, the demand for the euro will increase, making it more expensive and decreasing the relative price of the U.S. dollar.

Another example with a slightly different situation: if USDGBP is currently trading at 0.781 and a bunch of market participants decide to sell their dollars for pounds, the dollar's price is likely to lose value (forming the supply zone). If the price drops to 0.693 and everyone decides to buy (for example, because of some macroeconomic news), then the dollar is bound to start going up (forming the demand zone).

Factors that shift supply and demand in Forex

There are many factors that can influence the balance between supply and demand in trading.

• Economic indicators.

When a country's economy is doing well (growing), it attracts money from other countries. This means more people want to buy that country's currency, making it more valuable.

Inflation rates also affect the supply/demand balance. If prices in a certain country rise too fast (high inflation), the currency loses value, and fewer people want it. But if inflation is low, the currency looks better to investors.

You should also consider employment data. When many people have jobs, and the economy is healthy, more people want to invest in that country, increasing demand for its currency.

• Rates of interest.

When a country raises its interest rates, it can attract foreign money because investors want better investment returns. This increases demand for that currency. If rates go down, fewer people want it.

Central banks directly influence domestic interest rates, changing the balance of supply and demand. Lowering rates or printing more money can make the currency less appealing, leading to lower demand and lower prices in the market.

• Geopolitical factors.

Political stability can affect supply and demand rates. Countries with stable governments are seen as safer places to invest, which means more people will prefer to buy their currency.

Wars, elections, and trade disputes can change the number of people who want a currency. For example, when there's uncertainty due to a war, people tend to avoid buying the currencies of involved countries.

• Market sentiment.

Sometimes, traders feel brave and want to take risks by investing in currencies that could be volatile (moving up and down a lot). Other times, they prefer safer options. This affects the demand for different currencies.

Traders also buy and sell currencies based on news or trends, which can quickly change supply and demand. For instance, if a big news story breaks, some market participants might rush to buy or sell a currency.

Pros and cons of using supply and demand in trading

Pros:

• The strategy can help Forex traders identify key areas or zones that they must keep an eye on.
• Understanding supply and demand allows traders to get a deeper view of the market sentiment and traders' psychology.
• Supply and demand are the main drivers of currency prices. When more people want to buy a currency (demand exceeds supply), its price goes up, creating opportunities for traders to make profits.
• The Forex market is very liquid, meaning there are always buyers and sellers. This makes the S&D zones relevant in day-to-day trading, which is great for traders looking to capitalise on short-term changes.

Cons:

• Getting acquainted with S&D is relatively straightforward, but learning to implement it in your trading is not that simple: it requires being proficient in technical analysis and understanding the fundamental factors of trading.
• If the market is volatile, supply and demand zones can be hard to pinpoint, so traders can significantly benefit from factoring in macroeconomic news.
• Moreover, this strategy is subjective: one trader may not agree with the other about the location of the supply/demand zone on a specific graph.
• With low liquidity markets, the S&D strategy can give out false signals.

How to spot the supply and demand zones

Identifying these zones in Forex charts is like figuring out where people want to buy or sell something. Here's how to understand it.

What are the supply and demand zones?

The demand zone is a price point at which many people want to buy a specific currency. Buyers jump in when the price drops to this point, and the price usually goes up.

The supply zone is a price point where many people tend to sell currency. When the price rises to this point, sellers come in, and the price usually goes down.

In the above chart, the zone marked 1 indicates the supply zone. This is where the sellers jumped into the market and forced the currency to drop. Similarly, zone 2 is the demand zone; in this zone, there are more buyers than sellers (demand is higher than supply).

How can you find supply and demand zones?

1. Look at charts. Use price charts (candlestick charts preferred) to see how prices have changed over time.
2. Find reversal points. Look for places where the price suddenly changes direction. If the price drops quickly after hitting a certain level, that could be a supply zone.
3. Find consolidation areas. If the price stays around the same level for a while and then suddenly moves up or down, the top of that range might be a supply zone, and the bottom could be a demand zone.

In the chart above, the highlighted area is the consolidation. As we can see, the price moved up; this indicates that the bottom side is the demand zone. Similarly, if the price could have dropped from this zone then the upper side would have been the supply zone.

Find the support and resistance levels:

In the below chart, the resistance level marked 1 is where the price stops rising and starts to go down (supply zone).

The support level marked 2 is where the price usually stops falling and starts to rise (demand zone).

Look for volume:

If many people buy at a certain price, it shows strong demand. High trading volume at specific prices can help identify these zones.

Practise:

Use demo accounts or trading simulators to get better at spotting these zones without risking real money.

How to use the concept of supply and demand

You can adhere to the following plan.

1. Research currency trends

Check the news and events that affect currencies. For example, if a country's economy is doing well, more people will want that currency (high demand). Follow economic indicators like employment or interest rates, which can affect demand and supply.

1. Watch for price levels

Detect the support levels, where the price stops falling because buyers come in, and the resistance levels, where the price stops rising because sellers come in. If a currency hits the support level, it might be a good time to buy. If it hits a resistance level, it might be a good time to sell.

1. Use charts and indicators

To do this, learn to read Forex charts. They show you the price movements over time. Different indicators like moving averages or RSI (Relative Strength Indexes) can be used to help predict where prices might go based on supply and demand.

1. Practice risk management

Only invest what you can afford to lose. Set stop-loss orders to limit losses if things don't go as planned. Start with a demo account to practise trading without risking real money.

1. Stay updated

Keep an eye on global news. Remember that elections, natural disasters, and changes in government policies can affect supply and demand for currencies. Follow Forex forums and social media accounts that discuss currency trends.

Let's look at the following case: the US economy is booming (high demand for USD); more people want to buy USD to invest in the US. As demand for USD increases and supply stays the same, the value of USD goes up against EUR. You decide to buy USD when you see this trend starting. Later, when the USD has gained value, you sell it back for EUR at a higher price.

Tips for supply and demand trading

• It's wise to start on demo accounts with so-called 'virtual money' to train without losing anything.
• Study historical charts of different currencies to test out your theory in real-life scenarios (without putting any actual money on the table) and practise your skills.
• Always use several risk management techniques to secure your funds: invest only the money you can afford to lose entirely. Don't be too enthusiastic about borrowing assets from the broker because leverage can multiply your losses, not just profits.
• Create stop-loss and take-profit orders at critical levels. The former can help you avoid losing your funds if you need to get away from the screen for some time, while the latter allows you to benefit from an increase in prices even if you're not looking at the charts.

Supply and demand trading is a strategy used in financial markets to make decisions based on the principles of supply and demand. Here are some tips to help you effectively trade using these principles:

• Use multiple time frames. Analyse supply and demand on higher time frames (daily, weekly) to get a broader view of market trends and critical levels, and use lower time frames (15-minute, hourly) to time your entries and exits more precisely.
• Combine S&D with other indicators, such as Moving Averages, RSI, or MACD, to complement your supply and demand analysis. Do not forget to consider economic news and events that could affect market supply and demand.

In this chart, we see that the demand zone is confirmed by 5&13 Averages crossover, however, the traders can use any other combination of averages they find fit.

• Keep a trading journal: document your trades, including your analysis of supply and demand levels, entry and exit points, and outcomes. Regularly review it to learn from past trades and refine your strategy.
• Be patient and disciplined. Wait for confirmation instead of rushing into trades. Wait for the price to confirm that a supply or demand level is valid. Besides, follow your trading plan and avoid making impulsive decisions based on emotions.

Final thoughts

• Supply and demand in Forex indicate the potential zones where a certain currency may reverse.
• The price goes up when there are more buyers than sellers. But if more people want to sell a currency than buy it, the price goes down.
• Considering supply and demand helps traders predict where prices might go and make smarter choices. It can also show you the best times to buy or sell.
• However, figuring out these trends can be tricky, and sometimes you might get it wrong. That's why it's crucial to protect your money by setting limits on how much you're willing to lose.
• Overall, comprehending supply and demand can help you succeed in Forex trading.