The fundamental supply and demand that drive stock prices

In the financial markets, prices do not fluctuate randomly but are governed by fundamental economic principles—Supply and Demand—which determine trading volume and the direction of asset prices. This concept is not only the foundation of economics but also a crucial tool used by traders and investors to forecast price movements and time their market entries and exits.

Supply and Demand: The Basic Difference

When discussing Supply and Demand, how do they differ? The answer is that demand is the buying force, while supply is the selling force. These two forces operate inversely but together establish market equilibrium.

Demand (Demand): The buying force that drives prices up

Demand refers to the desire to purchase goods or services, including stocks and financial assets, at various price levels. Analyzing this demand produces a demand curve that shows the relationship between price and the quantity desired.

Law of Demand states that demand is inversely related to price: when prices fall, demand increases; when prices rise, demand decreases. This phenomenon is driven by two main factors:

Income Effect (Income Effect): When the price of a good decreases, the real value of the buyer’s money increases, enabling them to purchase more.

Substitution Effect (Substitution Effect): When prices drop, the good becomes more attractive compared to alternatives, prompting buyers to switch to this cheaper option.

Factors influencing demand in financial markets include interest rates, system liquidity, investor confidence, economic forecasts, and company news.

Supply (Supply): The selling force that pressures prices downward

Supply refers to the willingness to sell goods or services. In the stock market, supply indicates the volume of shares available for sale. The supply curve shows the relationship between price and the quantity that sellers are willing to offer.

Law of Supply is opposite to demand: the willingness to sell is directly related to price. When prices increase, sellers are willing to supply more; when prices decrease, the supply diminishes.

Factors affecting supply include production costs, technology, company policies, new listings, and future price expectations.

Equilibrium: The Point of Price Stability

Having only demand or supply alone cannot determine the market price. The actual price occurs at the Equilibrium (Equilibrium)—the point where demand and supply curves intersect.

At this point, the quantity buyers want matches the quantity sellers want to offer. Prices and quantities tend to stabilize because:

• If the price exceeds equilibrium, excess supply leads to inventory buildup, pushing prices back down toward equilibrium.
• If the price falls below equilibrium, excess demand causes shortages, pushing prices back up.

Supply and Demand in Financial Markets

Stock markets and other financial assets are arenas where the principles of supply and demand operate intelligently.

Factors Affecting Demand in the Market

Macroeconomic Factors: Economic growth, inflation rates, and interest rates directly influence demand. For example, lower interest rates encourage investors to seek higher returns in stocks, increasing demand.

Money Liquidity: When the financial system has more circulating money, the demand for risky assets tends to rise.

Confidence: Investors’ expectations about future economic conditions and corporate earnings significantly impact their buying and selling decisions.

Factors Affecting Supply in the Market

Corporate Policies: Decisions to raise capital or buy back shares directly affect the number of shares in circulation.

New IPOs: When new companies go public, the supply of securities increases.

Regulatory Requirements: Stock exchange regulations influence the offering of securities.

Analyzing Supply and Demand: The Trader’s Tool

Fundamental Analysis

Supply and demand principles help explain why stock prices move:

• Price Upward = Demand outpaces supply
• Price Downward = Supply exceeds demand

Fundamental factors such as earnings forecasts, company growth, or structural changes influence demand and supply, leading to price adjustments.

Technical Analysis

Technical tools enable traders to measure buying and selling pressures accurately:

1) Price Action on Candlesticks

• Green Candlestick (Close above open) = Buying pressure wins, demand is strong
• Red Candlestick (Close below open) = Selling pressure wins, supply is strong
• Doji = Equal forces, no clear winner

2) Market Trend (Market Trend)

If prices make new highs consistently, demand is strong, and prices tend to rise further. Conversely, if prices make new lows repeatedly, supply is dominant, and prices tend to fall.

3) Support & Resistance (Support & Resistance)

• Support = Price level where demand is waiting; when reached, prices tend to bounce back up
• Resistance = Price level where supply is waiting; when reached, prices tend to reverse downward

Demand Supply Zone Technique: Practical Application

This technique combines trend analysis with anticipation of potential price reversals.

Reversal Trading (Reversal)

1) Demand Zone Drop Base Rally (DBR) - From downtrend to uptrend

Occurs when: Excessive selling causes a rapid price drop (Drop), followed by stabilization (Base) within a narrow range due to opposing buy and sell forces. When positive news arrives, aggressive buying (Rally) pushes the price through the resistance.

Trading Entry: Buy at breakout of the consolidation zone with a stop loss below the zone.

2) Supply Zone Rally Base Drop (RBD) - From uptrend to downtrend

Occurs when: Excessive buying causes a rapid price increase (Rally), followed by stabilization (Base). Negative news triggers strong selling (Drop), breaking support.

Trading Entry: Sell at the breakdown of the support zone with a stop loss above.

Trend Following Trading (Continuation)

1) Rally Base Rally (RBR) - Uptrend continuation

Occurs when: Price surges (Rally), then consolidates (Base) within a range. When buying resumes, the price continues upward (Rally).

Trading Entry: Buy at the breakout of the rally zone, using the consolidation as a trigger.

2) Drop Base Drop (DBD) - Downtrend continuation

Occurs when: Price drops sharply (Drop), then consolidates (Base). When selling pressure returns, the price drops further (Drop).

Trading Entry: Sell at the breakdown of the support zone, with a stop above.

Applying the Principles

Supply and Demand are not just economic theories but fundamental mechanisms driving real-world markets. Traders and investors who understand these principles can read markets better, analyze more accurately, and make smarter investment decisions.

Whenever you notice an imbalance between supply and demand, it signals a potential price movement. Continuous study of actual prices and practice will help you maximize the application of this concept.