Understanding the meaning of supply and demand: The key to successful investing

When it comes to price movements in the financial markets, many people often see them as random fluctuations. But in reality, the prices of all assets—whether stocks or other financial instruments—are governed by the same fundamental mechanism: supply and demand. Understanding the concepts of supply and demand is not only fundamental to economics but also a valuable tool for predicting prices and making investment decisions.

Supply and Demand: Key Components of Market Price Determination

Basic Meaning

Demand (Demand) refers to the quantity of goods or services that buyers are willing to purchase at various price levels. Conversely, Supply (Supply) is the quantity of goods or services that sellers are willing to offer at different price levels.

When we graph demand and supply, the intersection point of the demand and supply curves is called Equilibrium (Equilibrium). This is the point where the actual market price and quantity are established.

Basic Law: Inverse Relationship of Demand

The law of demand states that when the price increases, the quantity demanded decreases; when the price decreases, demand increases. This phenomenon is driven by two factors:

Income Effect (Income Effect) - When prices fall, consumers’ purchasing power increases, allowing them to buy more.

Substitution Effect (Substitution Effect) - When the price of one good drops relative to another, consumers tend to substitute the cheaper good.

Basic Law: Positive Relationship of Supply

The law of supply is the opposite of demand: when prices rise, sellers are willing to supply more; when prices fall, they supply less.

Factors Affecting Demand

• Consumer income levels
• Tastes and preferences
• Number of consumers in the market
• Prices of related goods
• Expectations about future prices
• Psychological factors, such as consumer confidence

Factors Affecting Supply

• Production costs
• Technology
• Prices of substitute goods
• Number of producers
• Price expectations
• Natural conditions and external factors

Price Equilibrium: The Point Where the Market Finds Stability

Ideally, the market always moves toward the equilibrium point:

When prices are above equilibrium: Sellers produce and offer more, while buyers reduce their purchases, leading to a surplus (Surplus) that pressures prices downward back to equilibrium.

When prices are below equilibrium: Buyers want to purchase more, while sellers are less willing to sell, resulting in a shortage (Shortage) that pushes prices upward back to equilibrium.

Supply and Demand in Financial Markets: A Special Context

Financial markets are unique because the variables influencing demand and supply are complex and change rapidly.

Factors Driving Demand in Markets

Macroeconomic Conditions: Economic growth, inflation rates, and interest rates directly affect investment demand. For example, when interest rates are low, investors often seek higher returns in the stock market.

Liquidity Conditions: An increase in the money supply tends to bring more funds into the stock market, supporting demand.

Confidence and Expectations: Investors’ perceptions of future economic conditions, corporate earnings, and geopolitical situations influence their investment decisions.

Factors Driving Supply in Markets

Capital Raising Policies: When companies decide to raise capital or issue new shares, the supply of stocks in the market increases. Conversely, share buybacks reduce supply.

New Listings: IPOs of new companies add to the total supply of securities.

Regulations and Policies: Policies that support or restrict share sales by major shareholders affect supply.

Applying Supply and Demand Concepts in Technical Analysis

1. Demand and Supply Zone Analysis

The Demand Supply Zone technique is frequently used because it helps identify moments when prices lose equilibrium and seek a new balance.

Demand Zone Drop Base Rally (DBR) - Bullish Reversal:
Starting with a rapid price drop (Drop) due to excess supply, then the price forms a base (Base). When selling pressure diminishes and buying interest returns, the price surges (Rally) upward along a new trend. Traders buy at the breakout above resistance.

Supply Zone Rally Base Drop (RBD) - Bearish Reversal:
Prices rally (Rally) quickly, then form a base as buying slows. When selling pressure resumes, prices plunge (Drop). Traders sell at the breakdown below support.

2. Continuation Trends

Rally Base Rally (RBR) - Uptrend Continuation:
A prolonged uptrend characterized by higher highs, indicating strong demand. Investors can buy each time the price retraces.

Drop Base Drop (DBD) - Downtrend Continuation:
A prolonged downtrend with lower lows, indicating persistent supply. Investors should be cautious or prepare to sell on rebounds.

The Relationship Between Supply and Demand and Fundamental Analysis

In fundamental analysis, stock prices should reflect the company’s intrinsic value. When earnings forecasts change, demand (Demand) and supply (Supply) also shift.

Good news such as increased revenues, major contracts, or expansion plans will boost demand, leading buyers to pay higher prices, while sellers hold back.

Bad news like declining profits, increased competition, or management issues will reduce demand, causing buyers to hesitate and sellers to accelerate sales, leading to price declines.

Practical Trading Examples

Scenario 1: Increased Supply

When a company announces a capital increase, the supply of shares in the market rises immediately. If demand does not increase proportionally, the price may fall. Investors should wait until the market stabilizes and finds a new equilibrium.

Scenario 2: Share Buyback Strategy

When a company repurchases its shares, supply decreases. If demand remains the same, prices should rise. This indicates management’s confidence in the company’s value.

Scenario 3: Anticipated Price Rise

When investors expect prices to go higher, they tend to buy in advance, increasing demand before the actual event. Often, professional investors use big news before it becomes public.

Complex Factors Influencing Price Movements

In real markets, multiple factors often operate simultaneously. For example:

When the economy expands (increases demand), it may attract new companies to list (increase supply). The final outcome depends on which factor dominates.

Investors who understand how these factors interact can better interpret supply and demand signals and make smarter investment decisions.

Summary and Recommendations for Investors

Supply and demand are not just economic theories but practical tools for market analysis. Investors who understand the meaning of supply and demand and the dynamics of these forces can:

1. Identify entry and exit points by observing changes in supply and demand.
2. Forecast price reversals at new equilibrium levels.
3. Avoid pitfalls in areas of excessive surplus or shortage.

However, applying these theories requires patience and continuous practice. The more you observe real market prices, the better your trading instincts become. These experiences will help you become a more successful investor in the long run.