What are Supply and Demand Zones and How to Trade with Them?

3 Ara 2021

What are Supply and Demand Zones?

▷ Demand Zone (Accumulation Area):
Accumulation comes from a Latin word meaning to increase something over time.

A strong uptrend can only exist if buyers outnumber sellers. During a trend, price moves up until enough sellers enter the market to absorb the buy orders. The origin of strong bullish trends is called an accumulation or a demand zone. Demand Zone is where traders are willing to buy aggressively because the balance has shifted to the demand side. Here, buyers are dominant and sellers weak.

The demand zone represents a period of implicit buying, typically by institutional buyers, while the price remains fairly stable. This area is characterized by mostly sideways price movement. Before a trend starts, price stays in an demand zone until the “big players” have accumulated their positions and then drive price higher.

This can be contrasted with the Supply Zone, where institutional investors start to sell.

▷ Supply Zone (Distribution Area):
Bearish trends are created when sellers outnumber buy orders. Then, price falls until a new balance is created and buyers become interested again. The origin of a bearish trend wave is called a distribution or a supply zone. At Supply Zone traders are willing to sell aggressively because the balance has shifted to the distribution side. Here, sellers are dominant and buyers are weak.

Support and Resistance Levels vs. Zones
If you have an idea of how to trade with support and resistance zones, you might find supply and demand zones very similar.
You won’t be mistaken; Supply and demand zones are natural support and resistance levels. You’ll often find supply and demand zones just below/above support and resistance levels.

Types of Supply And Demand Patterns
There are two types of patterns: “Reversal” and “Continuation” patterns.

While a pattern is forming, there is no way to tell whether the trend will continue or reverse. As such, careful attention should be paid to whether the price breaks above or below the zone.

▷ Continuation Patterns
If price continues on its trend, the pattern is known as a continuation pattern.
We have two continuation patterns: “Rally-Base_Rally” and “Drop-Base-Drop”

▷ Reversal Patterns
When price reverses after a pause, the pattern is known as a reversal pattern. The established trend will pause and then head in a new direction as new energy emerges from the other side (bull or bear).

Reversals that occur at market tops are known as distribution patterns. Conversely, reversals that occur at market bottoms are known as accumulation patterns.

We have two reversal patterns: “Rally-Base_Drop” and “Drop-Base-Rally”



How to Find Supply and Demand Zones?
On a price chart, the demand zone is characterized by sideways price movement on above-average volume. When a stock price doesn't fall below a certain price level, and moves in a sideways range for an extended period, this can be an indication to investors that the stock is being accumulated by investors and as a result, will be moving up soon.

The demand and supply zones are encompassing the base on the beginning of the move. The most important thing is to first finding a sharp move in either direction, after which you can identify its starting point and roughly define the supply or demand zone:
• Look at the chart and try to spot successive large candles.
• Find the base from which price started the quick move. Usually, before that you have a small sideways move, that is where your supply / demand zone is.
• Draw the zone

It is very hard to be precise with those levels and here it is more of an art than science. To make it easier to identify these levels, you can use another tool for confirmation.

How to Trade with Them?
One way to trade with supply and demand areas is reversal trading. After identifying a previous strong market reversal, wait for the price to return to that area. If a false breakout occurs, the chance of seeing a successful reversal is extremely high.


Some candlestick patterns such as "Engulfing", "Pin Bar" and "Tweezer Blades" can help you identify trend reversals.

Be careful, trading in the opposite direction of the trend is very risky. Technical analysts typically recommend assuming a trend will continue until it is confirmed that it has reversed. Trend reversal trading can be a profitable way to trade the markets. However, like any other trading strategy, there is a correct and a wrong way to do it.

Pros and Cons
Being able to recognize whether an asset is in the demand zone or the supply zone is helpful to investing success. Demand Zone is the origin of a big rally in price. Identifying this area could help investors spot good entry points into an investment before its price begins to rise.

Once the price leaves an demand zone, not all buyers got a fill and open interest still exists at that level. Supply and demand traders can use this knowledge to identify high probability price reaction zones.

As with anything else, supply and demand zones have their cons, as well. Understanding chart movements such as those seen in the accumulation area can work well during times of relative stability. Still, prudent investors know to pay attention to larger economic events that can quickly reconfigure charts (like the covid-19 epidemic)

Key Points
• Accumulation / Re-accumulation zones can becomes distribution/Re-distribution zones over a period in the Stock Market
• The narrower a supply/demand zone before a strong breakout is, the better the chances for a good reaction the next time typically.
• Good supply and demand zones are quite narrow and do not hold too long, which shows strong imbalance between buyers and sellers.
• The stronger the breakout, the better the demand zone and the more open interest will usually still exist.
• Always look for extremely strong turning points. They are often high probability price levels.
• Each time the price re-tests a supply/demand zone, more and more previously unfilled orders are filled and the level is continually weakened.

Conclusions
Supply and Demand Zones are a great way to identify areas of buying and selling as well as support and resistance, but they work best when combined with other kinds of technical analysis.