Supply and demand drive market prices: Investors need to know this

If you’ve ever seen stock or asset prices plummet rapidly after news breaks or soar despite poor earnings reports, the answer often lies in the balance of buying and selling forces. Understanding demand and supply will help you see the market more clearly.

What is demand and why is it important to price

Demand (Demand) is the desire to buy goods or services at various price levels. When plotted on a graph, it forms a curve called the Demand Curve. Each point on this curve indicates the quantity buyers are willing to purchase at a specific price.

The law of demand states that when prices rise, demand decreases; when prices fall, demand increases. Why is this? Because two effects come into play:

Income Effect (Income Effect): When prices drop, your money has greater purchasing power, allowing you to buy more.

Substitution Effect (Substitution Effect): When prices decrease, this product becomes relatively cheaper than alternatives, prompting more purchases.

In financial markets, factors that drive demand include:

• Interest rates (Lower rates lead to more stock purchases)
• System liquidity (More money means more risk assets bought)
• Investor confidence (Good news encourages buying stocks without hesitation)
• Expected earnings (Anticipated profit growth attracts investment)

What is supply and how does it relate to price

Supply (Supply) is the willingness to sell goods or services at various price levels. When plotted, it creates a Supply Curve, with each point indicating the quantity sellers are willing to offer at a certain price.

The law of supply states that when prices are high, sellers are willing to sell more; when prices are low, they sell less. The reason is that higher prices mean higher profits, motivating increased production.

Factors affecting supply in stock markets include:

• Production costs (High costs discourage selling)
• Company policies (Share buybacks reduce supply; capital raising increases supply)
• New companies entering the market (IPOs increase the supply of securities)
• Technology and efficiency (Better production methods increase supply)

Equilibrium point: where the “real” price is

Demand or supply alone cannot determine the price. The actual price occurs at the Equilibrium (Equilibrium) point, where demand and supply curves intersect. At this point:

• The quantity buyers want to buy matches the quantity sellers want to sell
• The price tends to be stable

If the price rises above equilibrium, sellers want to sell more, but buyers buy less, leading to excess supply and a price correction downward. Conversely, if the price falls below equilibrium, buyers want to buy more, but sellers sell less, causing shortages and a price rebound.

Using demand and supply to time trades: Demand Supply Zone theory

In stock trading, the Demand Supply Zone technique applies this understanding:

First scenario: Price rises rapidly (Rally) then consolidates (Base)

A sharp upward move indicates strong demand, but as the price extends, sellers start to emerge, causing consolidation. If good news arrives and buying pressure overcomes, the price breaks above the consolidation zone and continues upward (called Rally Base Rally or RBR)

Second scenario: Price drops sharply (Drop) then consolidates (Base)

A quick decline signals abundant supply, but at low levels, buyers step in, causing consolidation. If bad news hits and selling dominates, the price breaks below the zone and continues downward (called Drop Base Drop or DBD)

Reversal points: Rally Base Drop (RBD) and Drop Base Rally (DBR)

Sometimes, when the price reaches a certain point, news or investor sentiment shifts, causing the trend to reverse. The price may rise to a consolidation and then fall further (RBD), or fall to a zone and then rebound (DBR).

Applying economic principles to analyze stocks in reality

While economists focus on charts and numbers, investors must consider real market conditions:

Fundamental analysis: If a company’s profits grow, investors buy more (demand surges), pushing the stock price up. If signals worsen, investors sell, increasing supply (supply surges), causing prices to fall.

Technical analysis: Observe green and red candlesticks. Large green candles indicate buying dominance; large red candles indicate selling dominance. A Doji (open and close at the same level) suggests indecision with balanced forces.

Summary

Demand and supply are not just economic terms but are the actual forces driving prices every day. Investors who understand this will see the market through a new lens, better predict trading opportunities, and avoid emotional trading. Timing stocks is essentially timing shifts in demand and supply.