How to Spot Supply and Demand Zones Properly. Supply and demand zones are powerful tools for understanding market dynamics. Traders can gain a deeper understanding of price movement by identifying these zones. However, identifying supply and demand zones is a challenge, since the market is constantly evolving and reacting to new information. In this article, we will explore the fundamentals of supply and demand zones, and how to spot supply and demand zones properly. Knowing your supply and demand zones is a valuable tool, regardless of your experience level.
What Are Supply and Demand Zones?
Supply and demand zones are key areas on a price chart where a security’s price has encountered a significant imbalance between buyers and sellers, resulting in price reversals.
A supply zone is an area on a chart where sellers have overwhelmed buyers, causing the price to drop. A demand zone is where buyers have overpowered sellers, causing the price to rise. These zones often occur at previous support and resistance levels, where the market has historically shown strong reactions to price movements.
What to know about Supply and Demand Zones
A supply zone is a price level region on a chart where traders typically sell, resulting in significant selling interest or potential.
When the price hits a recognized supply zone, the unfilled sell orders are executed, driving down the cost as the supply exceeds the demand.
Understanding supply zones helps identify potential price reversals and provides insights into when to enter or exit a trade.
A demand zone is a price level area where traders typically buy, resulting in significant buying interest or potential.
When the price reaches a recognized demand zone, the unfilled buy orders are executed, driving the cost as the demand exceeds the supply.
Recognizing demand zones helps to identify potential price reversals and provides traders with an understanding of when to enter or exit a trade.
Main Types of Supply and Demand Zones
There are two main types of supply and demand zones
- Reversal patterns: Reversal patterns are when the prevailing price trend changes direction, either from an uptrend to a downtrend or vice versa. Two common reversal patterns are;
- Drop-Base-Rally: In this pattern, the price first drops, then finds support and consolidates for some time at a particular price level (the base), before rallying higher.
- Rally-Base-Drop: In this pattern, the price first rallies, and then forms a consolidation (the base) before dropping significantly. In the supply zone, the rally-base-drop pattern is visible, with the price moving up, pausing for some time in the base structure, and then dropping sharply. The long candles that mark the drop indicate the strength of the supply-demand imbalance at that price level. In the demand zone structures, the drop-base-rally pattern can be observed, with the price falling significantly, forming a base, and then moving upward. The long candles representing the rally signal a strong demand-supply imbalance at that price level.
- Continuation patterns: Continuation patterns describe situations where the price trend continues moving in the same direction as the prevailing overall price trend, either up or down. These patterns tend to be weaker as the price often breaks through them. The two common continuation patterns are;
- Drop-Base-Drop: In this structure, the price initially drops, consolidates in a base structure for some time, and then drops further, continuing the downtrend. In the supply zone, the price drops significantly forms a base, and then continues to drop, following the drop-base-drop structure.
- Rally-Base-Rally pattern: In the demand zone, the price rallies up consolidates in a base structure, and then continues upward in a strong rally, forming the. The long candles indicate a continuation of the upward price movement.
How to spot Supply and Demand Zones properly
The first step in identifying supply and demand zones is to locate the current price on the chart. Once you have identified the current price, search for a large group of consecutive candles that are either moving up or down strongly. Typically, supply zones are preceded by significant upward price movements, while demand zones are usually preceded by strong downward price movements
Once you have identified the current price and located the preceding price movements, the next step is to find Equal Range Candles (ERC). ERCs are easily recognizable by their long bodies and small or nonexistent wicks. It is important to remember that candles with equal body and wick size are not considered ERCs. To be considered an ERC, the candle should have a body that is significantly longer than its wicks. These ERCs will form the basis of your supply and demand zones.
You need to pinpoint the origin of the price movement on the chart. Once you have identified the origin of the price movement, you can use it as the base of your supply zone.
Best Supply and Demand Zone Indicators
- Support and resistance levels are important concepts in technical analysis. They are price levels where the market has shown a tendency to pause, reverse, or change direction in the past, and are therefore considered key areas to watch in the future.
- Pivot points are a popular tool among traders to identify potential supply and demand zones or resistance and support levels. These points are calculated based on the previous day’s or week’s high, low, and closing prices, forming a baseline for the current trading day.
- Fibonacci levels are also commonly used to identify potential turning points at supply and demand zones. These levels are derived from the Fibonacci sequence.
Frequently asked questions
How long do supply and demand zones last?
- Supply and demand zones can last for minutes, hours, days, weeks, or even months. The duration of a zone depends on the level of supply or demand present and the market conditions at the time.
Can supply and demand zones be combined with other technical indicators?
- Yes, supply and demand zones can be combined with other technical indicators.
What is a false breakout of a supply or demand zone?
- A false breakout occurs when the price appears to break through a supply or demand zone, but then reverses back into the zone. False breakout signals a change in the market’s direction.