How to Use Supply and Demand Zones in Trading

Most textbooks for beginner traders focus on patterns and resistance/support levels. Many patterns are unambiguous, and levels and trend lines are easy to draw from visible extrema. But the financial market is flexible and unpredictable. Instead of a single reversal pattern, a double or even a triple top can be formed. The resistance level can be easily broken through with the trend continuation or on the contrary, the breakout can be false. The price may not reach the key levels or may reverse outside of them. Levels are lines formed by extrema, the range of price movement around these levels is a supply and demand zone.

In this series of articles you will learn:

• What are supply and demand zones in trading? How to identify their boundaries on the chart.
• What tools are used to find price imbalance ranges?
• How zonal models can be used in trading.

The given article will help you to understand the general reasons for the formation of zones of supply and demand, distinguish them from the classical key levels, and to learn to apply them in your strategies.

What are bid and ask zones?

Supply and demand zones are a part of the Price Action system. They represent the range where the maximum demand or supply is formed - there is a strong imbalance towards buyers or sellers. Price reversals after strong moves and the start of a new trend are most often seen in these zones.

An example to help you understand the essence and reasons for the formation of ranges:

• You sell apples at $50 USD per kilo. Other sellers are following your lead and also putting up a similar price. Buyers behave actively and buy up all the apples, the sellers have nothing left.
• The next day, some sellers decide to raise the price to 55 USD. The rest of the sellers didn't want to lose any extra income, so they also put the price at 55 USD. Apples are not so actively bought - it takes more time to sell the same amount of apples. But all the apples are still bought.
• The next day, some sellers decide to raise the price even higher, to 60 USD. Buyers don't like this price, and some of them refuse to buy. Some of the apples are not sold out, but the sellers are happy - the markup has paid for what they couldn't sell.
• The next day, the greediest seller sets the price at 65 USD. Others come after him, hoping that "they'll buy it anyway. But the buyers announce a boycott. The sellers reduce the price to 60 USD. But the buyers realize they are getting what they want and they continue the boycott. The price falls precipitously. As a result, the price comes back to 50 USD, buyers are happy and ready to buy again.

In this example, the level of 50 USD is a strong level, which is a resistance to the trend coming from the price of 10 USD. The price breaks through it and the resistance turns into support. After the growth to 65 USD, the price returns to 50 USD and pushes up from it again. It is possible that other fruits will appear on the market later and apples will fall in price to 10 USD again. But before that, the price chart will draw a couple more peaks at 65 USD. The area between 50 USD and 65 USD is the supply zone.

In the next article, we'll look at the steps to build supply and demand zones with examples.

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