Demand Supply is the foundation of investment - How should investors understand and apply it?

When it comes to investing in the stock market or predicting asset prices, many investors often overlook the most fundamental principle: understanding that Demand and Supply are the primary mechanisms driving price changes. Once you deeply understand this concept, you’ll be able to see price movements more clearly and make investment decisions with greater confidence.

Demand and Supply - Understanding the Forces That Drive the Market

Demand and Supply refer to the relationship between buyers’ desire to purchase (Demand) and sellers’ willingness to sell (Supply), which create the price movements in the market. This idea is not just economic theory but a natural law that causes stock, commodity, or asset prices to fluctuate. Studying this concept is essential for anyone wanting to understand how markets work.

First Component: Demand - The Buying Force

Demand indicates how much buyers want a product or stock at various price levels. When prices fall, demand tends to increase; when prices rise, demand tends to decrease. This is the basic Law of Demand, which shows an inverse relationship between price and quantity demanded.

The reasons behind demand changes are twofold:

• Income Effect: When prices drop, consumers’ purchasing power increases, allowing them to buy more.
• Substitution Effect: When the price of one product decreases, buyers may substitute it for more expensive alternatives.

Demand can also change due to various factors beyond price:

• Consumers’ income and purchasing power
• Prices of substitute or complementary goods
• Tastes and preferences
• Number of buyers in the market
• Expectations about future prices
• Seasonal and psychological factors

Second Component: Supply - The Selling Force

Supply reflects how much sellers or producers are willing to offer at different price levels. When prices increase, sellers are motivated to sell more; when prices decrease, their willingness to sell diminishes. This is the Law of Supply, which shows a direct relationship between price and quantity supplied.

Sellers tend to supply more at higher prices because:

• They can make higher profits
• They can cover production costs more easily

If prices are too low, sellers may choose not to sell at all because it’s not profitable.

Factors influencing supply include:

• Production costs
• Prices of alternative goods that can be produced
• Number of sellers in the market
• Technological advancements
• Future price expectations
• Tax policies and price controls

Equilibrium Point: Where Demand Meets Supply

The actual market price is not determined solely by demand or supply but at the point where the demand and supply curves intersect — called Equilibrium.

At this point, prices tend to stabilize because:

• If prices rise above equilibrium: sellers want to sell more, but buyers reduce demand, leading to excess supply, which pushes prices back down.
• If prices fall below equilibrium: buyers want to buy more, but sellers reduce supply, leading to shortages, which push prices back up.

This back-and-forth causes prices to oscillate around the equilibrium until new factors shift demand or supply.

Demand and Supply in Financial Markets - Why It Matters to Investors

In financial and stock markets, price movements are driven by complex factors affecting demand and supply. Understanding these helps investors interpret market signals more effectively.

Factors Affecting Demand in Markets

Macroeconomic Factors:

• Strong economic growth boosts investor confidence and demand
• Low interest rates encourage investment in stocks for higher returns
• High inflation may cause investors to seek refuge elsewhere

Liquidity and Investment Capacity:

• Abundant money supply in the economy provides more capital for investment
• High liquidity often leads to riskier investments

Confidence and Expectations:

• Expectations of corporate profits or economic conditions
• Political news and major information releases
• Overall consumer and investor sentiment

Factors Affecting Supply in Markets

Corporate Policies:

• Issuance of new shares increases available stocks
• Share buybacks reduce the number of shares in circulation

Entry of New Players:

• IPOs (Initial Public Offerings) add new securities to the market

Regulations and Restrictions:

• Restrictions on large shareholders selling after IPO
• Regulatory changes can impact the ability to issue or sell securities

Interplay of Factors

Often, multiple factors act simultaneously. For example, a booming economy (increased demand) may lead companies to go public more frequently (increased supply). The actual market movement depends on which force is stronger. Recognizing these relationships is a skill of professional investors.

Applying Demand and Supply to Stock Price Analysis

1. Using Demand and Supply in Fundamental Analysis

In fundamental analysis, stock prices reflect the company’s market value. Prices rise on “good news” that increases demand and fall on “bad news” that increases supply.

Examples:

• Better-than-expected earnings (good news) → increased demand → higher prices
• Lower-than-expected earnings (bad news) → increased supply (selling) → lower prices

2. Using Demand and Supply in Technical Analysis

Technical traders incorporate demand and supply concepts through various methods:

Candlestick Analysis:

• Green candles (close > open) indicate strong buying pressure
• Red candles (close < open) indicate strong selling pressure
• Doji (close near open) shows indecision

Trend Analysis:

• Higher highs and higher lows suggest strong buying and an uptrend
• Lower lows and lower highs suggest strong selling and a downtrend
• Sideways movement indicates balance between demand and supply

Support and Resistance Levels:

• Support zones are price levels where demand is strong enough to prevent further decline
• Resistance zones are levels where supply overwhelms demand, capping upward movement

Demand and Supply Zones in Trading

Demand and supply zones are technical tools used to identify potential reversal or continuation points by analyzing areas where demand or supply is concentrated.

Reversal Trading

1. DBR: Drop-Base-Rally (Downtrend then reversal)

Occurs when:

• Price drops sharply due to excess supply
• Then consolidates in a base (balance between buyers and sellers)
• Breaks out upward on positive news or momentum

Trading strategy: Buy on breakout above the base, with stop-loss below the base

2. RBD: Rally-Base-Drop (Uptrend then reversal)

Occurs when:

• Price rallies strongly due to excess demand
• Consolidates in a base
• Breaks down on negative news

Trading strategy: Sell on breakdown below the base, with stop-loss above the base

Continuation Trading

1. RBR: Rally-Base-Rally (Uptrend continuation)

Occurs when:

• Price continues upward with strong buying
• Pauses in a base
• Breaks out upward again

Trading strategy: Buy on breakout above the base

2. DBD: Drop-Base-Drop (Downtrend continuation)

Occurs when:

• Price continues downward with strong selling
• Pauses in a base
• Breaks down further

Trading strategy: Sell on breakdown below the base

Why Understanding Demand and Supply Is Essential

Demand and Supply are the foundation of price movements across all markets. Economists use them to explain prices; traders and investors use them to predict future trends.

Most importantly, Demand and Supply are not just theories — they are real mechanisms operating daily in markets. By understanding how buying and selling forces work, investors can see opportunities others might miss and make smarter investment decisions.

Mastering this concept requires practice: observing real market movements, continuous learning, and adapting to changing conditions. While markets are always evolving, the core principles of demand and supply remain constant.