How to Use Supply and Demand to Trade Stocks
If you want to find successful trading stocks, you must learn the basics of technical analysis. It’s one of the most powerful tools you can use to generate consistent gains.
Technical analysis can help you to leverage market forces to unemotionally select your best trades and boost your gains. You won’t be held hostage by market swings. And your trading strategy can be free to work optimally in a variety of market environments.
It all comes down to supply and demand.
A technical trader studies the supply and demand of a company’s stock. These are the two forces responsible for the movement of every single stock that is traded on an open market. You can study a stock’s price action — typically with charts — to determine where those supply and demand levels lie.
The important thing to remember is this: Supply and demand are the only factors that directly impact a stock’s price. Even though fundamental factors typically cause an increase in demand (and in price), those fundamentals can often become out of sync with market prices.
Think of any recent market correction. Both “good” and “bad” companies saw their share prices drop. And of course, you’ll also find stock in companies with strong fundamentals that are completely ignored by investors when the market is stable or moving higher.
However, when you study how supply and demand interact, you’ll no longer fret over these disconnects. Instead, you’ll know to use all of the available market data on a stock to produce high-probability trading setups.
Here’s how it works:
For most investors, the most-natural thing to do after buying a stock is to watch how it moves in relation to his or her entry price. We’ve all been there. Seeing your position move into gains or slide into losses has a huge impact on whether you choose to continue to hold shares or sell them. Remember, those entry prices are past prices. These past prices are significant. They’re the prices paid by tens of thousands of individual investors. So as a result, the decision making of those investors is based almost entirely on past prices.
One of the main goals of technical analysis is to identify and exploit these psychologically important price levels. That’s why charts are a key component of the practice. Charts offer us a quick, thorough glance at past price action. By analyzing certain formations on stocks charts, we can find the emotional pivot points that investors and traders have deemed the most significant. This is how trading opportunities are born.
Take a look at this simple chart:
Here we have a stock that has traded between $44 and $48 almost all year. So anyone who bought shares so far this year has an emotional connection to a price somewhere between $44 and $48.
Remember, these past prices are significant because of the investors who bought at these levels. If the price moves above the blue line, investors will be less willing to give up their winning position. This tightens the supply of shares while demand increases, helping the stock move higher. The opposite would happen if shares were to fall below the red line. Frustrated investors would probably sell, flooding the market with cheaper shares. Now you can see how analyzing supply and demand is a simple way to find high-probability setups in reaction to the market.
Believe it or not, there’s a difference between being right and making money. By focusing on contingent expectations of a stock (and what to do if they don’t work out), you can stop worrying about being right or wrong and just take consistent gains out of the market instead.
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