How to Use the Law of Supply and Demand to Understand Asset Price Movements

In the investment world, many traders often overlook fundamental concepts. However, there is one idea that all financial families constantly use—it’s the principle of supply and demand, which has a greater influence on asset pricing than many realize.

The Supply and Demand Rules That Drive the Market

At the core of economic theory is the idea that the price of any good is not determined by a single factor but results from the struggle between buyers and sellers.

Demand represents the quantity consumers want to purchase at various prices. When we look at the graph showing this relationship, the demand curve slopes downward from left to right. This reflects a basic rule: when price increases, the quantity demanded decreases; when price decreases, demand increases.

Supply is the opposite—it is the quantity sellers are willing to offer at different prices. The supply curve slopes upward from left to right. The higher the price, the more willing sellers are to supply.

( Income and Substitution Effects

The reason demand decreases as price rises relates to two economic phenomena:

Income Effect: Changes in price affect the real value of the buyer’s income. If prices fall, your same salary can buy more, leading you to purchase larger quantities.

Substitution Effect: When the price of a good changes, it becomes more or less attractive compared to other goods. If one product becomes cheaper than alternatives, consumers tend to switch to that product.

) Factors Influencing Demand

Demand is not only dependent on price. Other influential factors include:

• Consumer income levels
• Prices of substitute and complementary goods
• Customer preferences and tastes
• The number of consumers
• Future price expectations
• Cultural and seasonal changes
• Government policies
• Consumer confidence

( Factors Influencing Supply

On the seller’s side, the following factors affect the quantity of goods offered:

• Production costs
• Prices of production inputs
• Technology status
• Prices of substitutes and complements from the producer’s perspective
• Expectations about future prices
• Number of sellers in the market
• Liquidity conditions and access to capital
• External factors such as natural disasters and policy changes

Equilibrium: The Point Where the Market Finds Balance

When the demand and supply curves intersect, they create a point called equilibrium). This is the price### and quantity### where the market clears.

At this equilibrium point:

• The quantity buyers want to buy equals the quantity sellers want to sell
• There is no pressure for the price to change
• The market is in balance

When the Price Is Above Equilibrium

If the price rises above the equilibrium point, sellers find themselves with excess inventory because consumers are unwilling to buy at high prices. This surplus forces prices down until they return to equilibrium.

( When the Price Is Below Equilibrium

Conversely, if the price drops below equilibrium, buyers want more units than sellers are willing to supply. This shortage gives sellers more bargaining power—they can raise prices. This process continues until the market reaches equilibrium.

How to Adjust Supply and Demand in the Financial Markets

In investing, supply and demand are not as straightforward as in a fruit market. Many factors influence buying and selling of assets.

) Changes in Demand in Financial Markets

Macroeconomic conditions greatly influence demand. When interest rates are low, investors are encouraged to “make money work” and seek higher returns through stocks or other assets. Conversely, when interest rates are high, bonds and savings accounts become more attractive, reducing demand for stocks.

System liquidity: If the amount of money circulating in the market increases, consumers and investors have more funds available for investment, generally boosting demand for assets.

Investor confidence: Plays a significant role. When the outlook looks positive, people tend to buy; during fears of recession, they tend to sell.

( Changes in Supply in Financial Markets

Corporate decisions: Directly impact supply. Public companies issuing new shares increase the total number of shares available, raising supply. Conversely, share buyback programs reduce the number of shares and supply.

New IPOs: When a company enters the stock market for the first time, it introduces new securities, temporarily increasing supply.

Regulatory changes: Stricter governance or tax policy changes can reduce the conditions for issuing new securities or cause major shareholders to wait before selling their holdings.

Applying Supply and Demand Rules to Stock Trading Timing

These fundamental principles are not just academic—they can be used to help traders anticipate market movements.

) Fundamental Analysis: Company Profile

From a fundamental perspective, the driving force behind stock prices comes from forecasts of the company’s future earnings. Stock prices represent the total value of the company.

If analysts give a positive outlook, investors will buy more, willing to pay higher prices to acquire shares, pushing prices upward.

Conversely, negative news causes buyers to withdraw, while sellers rush to exit, leading to a sharp decline in price due to increased supply.

Technical Analysis: Reading Price and Volume

Technical traders use various tools to detect the “signals” of supply and demand.

Candlesticks and Price Action

Green candlestick ###closing higher than opening### indicates buyers won the battle that day. Buying momentum is strong, and prices tend to push higher.

Red candlestick ###closing lower than opening### indicates sellers won. Selling pressure is increasing, and prices may continue downward.

Doji candlestick ###opening and closing at the same price( shows indecision between buyers and sellers, with no clear winner.

)# Support and Resistance

Support (is where buyers are likely to step in because they see it as a valuable price. When prices fall to this level, buying often appears, preventing further decline.

Resistance )is the opposite—where sellers are waiting. When prices rise enough, they release shares, and selling pressure often halts or reverses the trend.

(# Trend Assessment

In a true uptrend, prices make new highs while pullbacks are shallower. Demand remains dominant.

In a true downtrend, prices make new lows while previous rallies are decreasing. Supply is in control.

Supply and Demand Rules in Demand Supply Zone Trading

One popular technique is the Demand Supply Zone )DSZ###, which uses these concepts to identify specific buy and sell points.

( Uptrend: DBR )Demand-Base-Rally(

When prices drop sharply )Drop### due to excess selling, then pause or stabilize (Base) as selling weakens and buyers start to enter. Eventually, with new catalysts, prices rally ###Rally( again.

Traders can buy at breakout points when prices break through the established base.

) Downtrend: RBD (Rally-Base-Drop)

Conversely, when prices rise (Rally) due to excess buying, they pause at a high level (Base). When buyers decide the price is too high and negative news hits, prices plummet ###Drop( quickly.

Short sellers often sell at the lower breakout of the base.

) Trend Following: RBR and DBD

Often, there is no reversal; instead, prices form a base briefly and then continue in the same direction.

• RBR (Rally-Base-Rally): Temporary buying pause, but after the base, prices continue upward.
• DBD (Drop-Base-Drop): Short-term selling pressure, but after the base, prices continue downward.

Summary: Using Supply and Demand Rules

Understanding supply and demand rules is not about perfect textbook knowledge but is a powerful tool in an investor’s toolkit. It helps us see that behind price movements, there are two forces battling each other.

Successful traders are not those who master the theory perfectly but those who take action, observe the market, and learn to recognize these patterns firsthand.