Supply and demand is a fundamental principle of economics and plays a significant role in the Forex market. Traders who understand the concept of supply and demand can use it to identify profitable trades, reduce risk, and increase their chances of success.
Successful traders use supply and demand to identify key support and resistance levels in the market. Support levels are the price points at which traders buy a currency, believing that it is now undervalued and will increase in value. Resistance levels, on the other hand, are price points at which traders sell a currency, believing it is now overvalued and will decrease in value.
Table of Contents
- Breaking Support and Resistance Levels
- Analyzing Trends
- Combining Technical and Fundamental Analysis
Here are a few examples of successful trading strategies based on supply and demand in Forex:
Breaking Support and Resistance Levels
One of the most simple trading strategies based on supply and demand principles is to watch for price action to break through support or resistance levels. When prices break through these levels, it usually indicates a significant shift in supply or demand and traders can use this as a signal to enter a trade.
For example, if the price of a currency repeatedly tests a particular resistance level and then suddenly breaks through it, traders can enter a buy trade as this indicates that there is significant demand for that currency at that particular price point.
Here is an example:
On the chart below, GBP/USD tested the resistance level at 1.26304 twice and was able to break above it at the third try. Once the break happens, we locate the origin of the rally that caused the breakout (which is the newly formed demand zone). We draw our demand zone and wait for price to test it to go long.
Traders who use supply and demand principles also pay attention to trends. Trends are the overall direction of price movements over a certain period of time, and they can help traders identify support and resistance levels.
If a currency pair is in an uptrend, prices will generally be rising over time, and traders will look for support levels where they can buy the currency, anticipating that the uptrend will continue.
Conversely, if a currency pair is in a downtrend, traders will look for resistance levels where they can sell the currency, anticipating that the downtrend will continue.
Combining Technical and Fundamental Analysis
Successful Forex traders combine technical and fundamental analysis to identify the supply and demand factors that affect currency prices. While technical analysis uses charts and other visual tools to analyze market data, fundamental analysis focuses on the economic and political events that affect the supply and demand of a particular currency.
By using a combination of technical and fundamental analysis, traders can identify the most significant support and resistance levels and enter trades with a higher probability of success.
To combine technical and fundamental analysis to identify supply and demand in Forex, you can follow these steps:
- Start with analyzing the fundamental factors that influence the currency pair you want to trade. This includes economic indicators, central bank policies, geopolitical events, and other macroeconomic factors that affect supply and demand.
- Use technical analysis tools to identify trends, support and resistance levels, and key chart patterns that signal changes in supply and demand dynamics. These tools can include moving averages, Fibonacci retracements, trend lines, and candlestick patterns.
- Look for confluence between the technical and fundamental factors. For example, if a currency pair is approaching a key technical resistance level (supply zone) while also experiencing bullish fundamental factors (such as positive economic data and hawkish central bank statements), this could signal a potential reversal or breakout.
- Use risk management techniques to manage your trades based on the identified supply and demand factors. This can include setting stop losses and take profits, monitoring market volatility and news announcements, and adjusting your trade size based on your risk tolerance and the prevailing market conditions.
Here is an example:
Market is expecting the Nonfarm Payroll number to be released at 1:30 p.m. (GMT+1) and USDCHF is already moving up. As the price breaks above the resistance level at 0.89253, we can anticipate a bullish continuation to the upside.
In this case, we combined the bullish technical bias with the market expectation to a more positive NFP number.
As we can see on the chart below, price broke above the resistance giving up a bullish confluence to buy the USDCHF and around the released of the NFP number, market jumped higher and tested the supply zone around 0.89655-0.89921 levels.
Understanding supply and demand principles is essential for profitable trading in the Forex market. Successful traders use these principles to identify key support and resistance levels, analyze trends, and combine technical and fundamental analysis. By incorporating these strategies into their trading plans, traders can reduce risk and increase their chances of success.