Education post 6/100 – How to trade supply and demand zones?

FX:GBPAUD   British Pound / Australian Dollar
Supply and demand is a trading and price action concept that analyses how financial markets move and how buyers and sellers drive the price.

On every price chart, there are certain price points where you can observe a sudden shift between the buyers and the sellers. Those areas are usually characterized by strong and immediate turning points, or an explosive breakout. We as traders call those areas supply and demand zones.

It can pay off to know how to spot such areas because just like the concept or  support and resistance , supply and demand areas can add an other layer of confluence to our trading and help us find better trades.

Order absorption – why common trading knowledge is wrong
The scenario below is something we all have seen hundreds of times. It shows the classic price behavior around a support level . Common trading wisdom tells you that with each touch of a price level, the support area becomes stronger. This couldn’t be further from the truth.

What makes the price go down is an imbalance between buyers and sellers and there is more selling activity than buying going on. Each time the price reaches the support level , buyers enter the market and cause a bounce by outnumbering the sellers. Then, the price rises until sellers become interested again, outnumber the buyers and drive the price down. Although this is a very simplistic view, it explains how markets move.

But each time the price makes it to the support level , there will be fewer buyers waiting because, at one point, all buyers who were interested in buying have executed their trades. This is called order absorption. The screenshot shows that price bounced less high with each “touch” and eventually it broke the support level once there were no more buyers left and only the absorbing sellers remained.

When everyone has bought and when there are no buyers left, the support level will break and price falls until it reaches a price level where buyers will get interested again.

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