As is true in all markets, whether it’s used cars, produce, real estate, industrial products or anything else, the interaction between supply and demand determines prices in trading markets.
Each buyer (the demand) bids for a certain quantity at a certain price, and each seller (the supply) offers or asks for a certain quantity at a certain price.
The market is what we call a “zero sum” game. Each transaction requires both a willing buyer and a willing seller in order to consummate a transaction.
When both the buyer and seller agree and transact, they establish a price for that moment in time.
The reasons for buying and selling can be complex. Perhaps the seller needs the money. Perhaps the seller has learned of unfavorable information.
Or perhaps the buyer heard a rumor in the country club locker room. It’s really irrelevant.
Whatever the reason might be, the price is established once all this information is collected, digested and acted upon through the bid and the offer.
Price, therefore, is the end result of all those inexact factors, and it is the result of the supply and demand at that instant in time.
When prices change, the change is due to a change in either demand, supply or sometimes both.
The seller might be more anxious, or the buyer might have more money to invest. Whatever the reason, the price will change and reflect this change in supply or demand.
The technical analyst watches price action but does not particularly worry about the reasons, largely because they are unable to be determined.
Remember that many players for many reasons determine supply and demand.
In the trading markets, supply and demand may come from long-term investors accumulating or distributing a large position or from a short-term trader trying to scalp a few points.
The number of players and the number of different reasons for their participation in supply and demand is close to infinite.
Thus, the technical analyst believes it is futile to analyze the components of supply and demand except through the prices it creates.
Where economic information, company information and other information affecting prices is often vague, late or misplaced, prices are readily available, extremely accurate, have historic records and are specific.
What better basis is there for study than this important variable?
Furthermore, when one invests or trades, the price is what determines profit or loss, not corporate earnings or Federal Reserve policy.
The bottom line to the technical analyst is this: Volume precedes price action. And price action is reactive to supply and demand.
Next time you see a major change in price or trend, the above statement will likely be abundantly apparent!
A great example of supply and demand is pictured above in the weekly chart of the US Dollar Index.
As you can see in the broader picture, it’s apparent that the sellers find supply stepping in at the same place repetitively, and the buyers find demand and do the same.
This process will repeat itself over and over again until an imbalance occurs and one of the two outweighs the other enough to break and/or form a new pattern.
Rules to Live By
“Imperfection is beauty, madness is genius and it’s better to be absolutely ridiculous than absolutely boring.”
― Marilyn Monroe
Until next time, I wish you a beautiful and blessed day!
Yours In Trading Success,
Anthony Speciale Jr.