The Laws of Supply and Demand: Essential Tools Every Investor Must Know

When it comes to stock price predictions, investors often look for something mysterious or complex. But in reality, the simplest and most effective principle comes from basic economics: the law of supply and demand, which is not just lively in textbooks but can also be used as a tool to forecast market trends in real trading.

Why investors need to understand the law of supply and demand

Stock prices do not rise or fall randomly. They are the result of the clash between buying and selling forces. When there are many buyers willing to purchase at higher prices, the price will go up. Conversely, when there are many sellers wanting to sell at lower prices, the price will decrease.

This concept is the foundation of almost all economic theories and may explain why professional traders worldwide still use this principle to understand market and consumer behavior.

What is (Demand)?

Demand (Demand) refers to the quantity of goods or services that buyers want at each price level. When we plot these data points on a graph, we get the (Demand Curve), which shows the relationship between price and the quantity desired by buyers.

Each point on this curve tells us two things:

• The quantity of goods buyers want at a certain price
• The maximum price consumers are willing to pay for that quantity

Basic principle: the law of demand

The law of demand and supply states that, for demand, when prices increase, the desire to buy decreases, and vice versa. This mechanism is driven by two main factors:

1) Income Effect (Income Effect) When the price of a good decreases, our purchasing power increases. Think of when coffee prices drop; we can buy more coffee with the same budget or use the remaining money to buy other things.

2) Substitution Effect (Substitution Effect) When the price of a good changes, we compare it with similar products. For example, if coffee becomes more expensive, many people might switch to drinking tea instead.

Factors driving demand

Besides price, other factors influence demand:

• Consumer income levels
• Prices of related goods
• Consumer tastes and preferences
• Market size
• Future price expectations
• Seasonal factors and new technologies

What is (Supply)?

Supply (Supply) is, in contrast to demand, the quantity of goods that sellers want to offer at each price level. The (Supply Curve) shows the relationship between price and the quantity sellers are willing to sell.

Each point on this curve indicates:

• The quantity of goods sellers want to sell at a certain price
• The minimum price sellers are willing to accept to supply that quantity (Minimum Acceptable Price)

Basic principle: the law of supply

Unlike demand, which has an inverse relationship, the law of supply states that, as prices increase, sellers want to sell more because profits are higher. Conversely, when prices decrease, sellers want to sell less.

Why is this the case? Because most sellers aim to maximize their profits.

Factors influencing supply

Factors affecting supply include:

• Production costs (Raw materials, labor, technology)
• Prices of alternative goods that producers can manufacture
• Number of competitors in the market
• Technology and innovation
• Future price expectations
• Tax policies and price controls
• Weather and external factors

Equilibrium point: where prices “pause” temporarily

If only demand and supply existed, we couldn’t determine the price. Prices would self-adjust when the demand and supply curves intersect at that point, called Equilibrium (Equilibrium).

At this equilibrium point:

• The quantity demanded equals the quantity supplied
• Prices have no pressure to change

When deviating from this point, automatic adjustment mechanisms occur:

If the price rises above equilibrium:

• Sellers produce more, but buyers purchase less
• Excess inventory occurs, and prices are pushed down

If the price falls below equilibrium:

• Buyers want to buy more, but sellers sell less
• Shortages occur, and prices are pushed up

This mechanism gradually restores the price to the equilibrium point.

In financial markets: more complex factors

In stock and financial markets, supply and demand are much more complex than in typical goods markets.

Common factors driving demand in financial markets

Macroeconomic factors:

• Interest rates (Low interest = more people invest in stocks)
• Inflation rates
• Economic growth rates

System liquidity:

• Total money supply in the economy
• Central bank policies

Investor confidence:

• Earnings forecasts
• Political stability
• Future economic outlook

Factors driving supply in financial markets

Corporate decisions:

• Capital raising (Issuing new shares = increased supply)
• Share buybacks (Reducing the number of shares in circulation = decreased supply)

News and information:

• IPOs of new companies
• Announcements and regulations related to stock exchanges

General conditions:

• Borrowing costs
• Market sentiment

Applying fundamental analysis

When it comes to fundamental analysis, supply and demand reflect this clearly:

Rising stock prices = strong demand Indicates buyers see good opportunities in the company, possibly due to:

• Positive earnings reports
• Optimistic growth forecasts
• New product developments

Falling stock prices = strong supply Indicates most sellers are offloading, possibly due to:

• Poor earnings or outlook
• Negative news
• Policy changes unfavorable to the company

Fundamental analysts use forecasts of key factors to assess whether demand or supply will dominate the market.

Applying technical analysis

Technical traders use the law of supply and demand through various tools and techniques:

1) Candlestick analysis (Candle Stick Analysis)

Green candlestick (Close > Open):

• Indicates buying pressure during the day
• Strong demand

Red candlestick (Close < Open):

• Indicates selling pressure during the day
• Strong supply

Doji (Doji):

• Equal buying and selling forces
• No clear direction

2) Trend analysis (Market Trend)

Uptrend (Uptrend):

• Prices make higher highs
• Indicates demand remains strong

Downtrend (Downtrend):

• Prices make lower lows
• Indicates supply remains strong

Sideways (Sideways):

• Demand and supply are balanced

3) Support & Resistance (Support & Resistance)

Support (Support):

• Level where buying interest (Demand is strong)
• Investors wait to buy at lower prices

Resistance (Resistance):

• Level where selling interest (Supply is strong)
• Investors wait to sell at higher prices

Practical case study: Demand Supply Zone technique

Demand Supply Zone is a popular technique that uses the law of supply and demand to identify good buy/sell opportunities.

This technique looks for “Zones” (areas) where demand or supply consolidates.

4 main patterns:

1) DBR (Demand Zone Drop Base Rally) - Support zone:

• Price drops sharply (Drop)
• Then pauses and forms a base (Base)
• Finally reverses upward (Rally)
• Traders buy at this zone

2) RBD (Supply Zone Rally Base Drop) - Resistance zone:

• Price rises sharply (Rally)
• Then pauses and forms a base (Base)
• Finally reverses downward (Drop)
• Traders sell at this zone

3) RBR (Rally Base Rally) - Continuous up move:

• Price rises, forms a base
• Then continues upward
• Indicates demand remains strong

4) DBD (Drop Base Drop) - Continuous down move:

• Price drops, forms a base
• Then continues downward
• Indicates supply remains strong

Summary

Supply and demand are not just theories sitting in textbooks. They are the forces driving markets every day, whether in commodities, stocks, or any financial market.

Successful investors are often not the smartest but those who understand these fundamental principles most deeply and apply them appropriately.

Learning the law of supply and demand may take time, but this effort will help you read the market more accurately in the future.