The Mechanics of Supply and Demand Applied to Forex

Many begining Forex traders don't really know why the price moves in a certain direction and trade without realising how the market really works and where all that money is coming from.

The truth is, like in any market, it's all about supply and demand. No matter what Elliot Waves show you, Fibonacci retracements, MACD, Stochastics or Moving Averages, it's just the laws of supply and demand that govern the market. All you need to look at to be profitable is price and time.

So what is supply and what is demand?

The definition of supply is: "Supply is the amount of something, such as a product or service, that a market has available". So, where there are sellers, there is supply.

The definition of demand is: "Demand is the amount of the product or service that buyers want to purchase". Where there are buyers, there is demand.

Price moves up in a chart if demand is greater than supply (there are more willing buyers than sellers, or the total amount of cash buyers want to get is higher than the total amount of cash that sellers are willing to give). Price moves down in a chart if supply is greater than demand (more willing sellers than buyers). This shouldn't be hard to understand. Let's say we have ten buyers and five sellers. Once all sellers have sold, we have five buyers and no sellers. Price will rally up until it finds a good stack of sellers that are willing to supply the buyers with products (in our case, cash). When there is a balance between sellers and buyers, the market is stalling and moving sideways. When there is an imbalance, the market is moving either up (demand higher than supply) or down (demand lower than supply).

How can we use this in our favour?

What is the logical thing to do when prices are droping? If you thought "sell", then you're wrong. It's not logical to sell after a period of selling. You can only make money if other novices like you will jump in and continue to sell after you do so. What does a business man do when housing prices drop 50%? Does he sell all his properties? No, but instead he buys more, because it's cheap. And because prices will eventually rise again and he can sell at a bigger price than the price he paid.

So, it is a bad move to sell after a period of selling or to buy after a period of buying. It is a good deal to buy after a period of selling and sell after a period of buying. But how do you find the right time to buy or sell, so that your risk is very low, your stop loss orders are tight and your reward potential is high? This is where levels of supply and demand (also known as support/resistance) come in. You can see some examples in the chart attached to this article.