Supply and Demand: The Fundamentals of Price Setting in Financial Markets

In the financial markets, asset prices do not just happen out of thin air; they result from the decisions of countless buyers and sellers. Understanding the underlying mechanisms allows investors to have powerful tools to more accurately forecast price directions. In this article, we will explore how demand and supply influence price movements in the financial markets and how to apply this knowledge to investment decision-making.

Factors Driving Prices in Financial Markets

Before delving into each component, we must understand that in financial markets, buyers and sellers are constantly interacting at various price levels.

• (Demand) refers to the quantity of assets investors wish to purchase at different price levels. As prices decrease, demand tends to increase; conversely, as prices rise, demand usually decreases.
• (Supply) is the quantity of assets sellers are willing to offer at different price levels. This behavior is opposite to demand: at higher prices, sellers are more willing to sell; at lower prices, they tend to hold back.

When the demand and supply curves do not intersect, the market is in imbalance. Prices will adjust until they meet at a point called (Equilibrium), where the quantity demanded equals the quantity supplied. This is the point where prices tend to stabilize.

What is Demand?

Demand arises from investors and consumers wanting to own assets. When plotting quantity versus price, we get the (Demand Curve), which slopes downward. Simply put, lower prices lead to higher purchase quantities, and higher prices lead to lower purchase quantities.

###(The Law of Demand)

This relationship is driven by two deep factors:

Income Effect (Income Effect) - When prices fall, consumers have more disposable income, enabling them to buy more goods. It’s like your money becomes more valuable.

Substitution Effect ###Substitution Effect( - When the price of a particular asset drops, it becomes relatively cheaper compared to similar assets, prompting investors to switch and buy this cheaper alternative.

)Factors Affecting Demand

Demand is not determined solely by price; other factors also influence it:

• Investors’ income levels
• Prices of related assets
• Investment preferences or confidence
• Number of market participants
• Future price expectations
• Seasonal factors and special events

For example, if the economy is growing well, investors have more money, increasing demand for investments. Similarly, positive news about a company boosts confidence, leading to higher demand for its stocks.

What is Supply?

Supply is the quantity of assets that sellers or producers are willing to offer at various price levels. The ###Supply Curve### slopes upward. This relationship is opposite to demand: higher prices lead to more selling, lower prices lead to less.

######The Law of Supply(

As prices increase, sellers are willing to offer more because their profits grow. Conversely, when prices decrease, profits shrink, and they tend to hold back on selling.

)Factors Affecting Supply

• Production or acquisition costs
• Prices of alternative goods that can be produced instead
• Number of sellers in the market
• Technology availability
• Future price expectations
• External factors such as natural disasters, tax policies, and exchange rate volatility

For instance, if production costs rise, producers will reduce output. If a new company enters the market via an IPO, the supply of shares increases.

Equilibrium and Price Setting

Actual market prices are not determined solely by demand or supply but by their intersection point at (Equilibrium), where the quantity buyers want matches the quantity sellers want to offer.

Why do prices tend to stay at equilibrium?

• Prices too high: Sellers want to sell more, but buyers want to buy less, leading to excess inventory. Sellers then lower prices.
• Prices too low: Buyers want to buy more, but sellers want to sell less, causing shortages. Prices are pushed upward.

Through this mechanism, prices tend to gravitate toward equilibrium until new factors intervene.

Demand and Supply in Financial Markets

In stock and financial asset markets, the principles of demand and supply still apply, but the influencing factors are more complex.

(Macroeconomic Factors Affecting Demand)

• Interest Rates: When rates are low, investors prefer stocks for higher returns.
• Economic Growth: Improving economy boosts investor confidence and demand.
• Liquidity: More money in the system increases investment demand.
• Market Sentiment: Expectations and political situations.

###Factors Affecting Supply(

• Corporate Policies: Capital raising or share buybacks directly affect supply.
• New Listings )IPO(: Entry of new companies increases supply.
• Market Regulations: Conditions like Silent Periods limit large shareholders’ ability to sell.

Both sides interact, and their combined effects influence prices. When the economy is strong, demand increases, and companies may go public more often, increasing supply. The overall impact on price depends on the balance of these forces.

Basic Analysis Using Demand and Supply

Fundamental analysis views stock prices as representations of a company’s intrinsic value. Factors influencing profit forecasts cause demand and supply to shift.

• Good news: Better-than-expected earnings reports or expansion plans increase demand → buyers willing to pay higher prices → prices rise.
• Bad news: Losses or competitive issues decrease demand or increase supply → sellers willing to lower prices → prices fall.

Technical Analysis Using Demand and Supply

Technical traders use various tools to observe buying and selling pressures.

) 1. Candlestick Analysis (Candle Stick Analysis)

• Green candlestick (Close > Open): Buying pressure dominates; demand is strong; prices may continue upward.
• Red candlestick ###Close < Open(: Selling pressure dominates; supply is strong; prices may continue downward.
• Doji )Open ≈ Close###: Equal forces; market hesitation; price may reverse or consolidate.

( 2. Trend Analysis )Market Trend###

• Uptrend: Prices make higher highs and higher lows, indicating strong demand.
• Downtrend: Prices make lower lows and lower highs, indicating strong supply.
• Range-bound movement: Prices fluctuate between support and resistance levels, showing indecision.

( 3. Support & Resistance )Support & Resistance(

• Support: Price level where demand tends to emerge, preventing further decline.
• Resistance: Price level where supply tends to emerge, preventing further rise.

Demand and Supply Zones in Trading

A popular technique involves using Demand and Supply Zones to identify reversal points and continuation patterns.

) Reversal Trading (Reversal)

Demand Zone Drop Base Rally (DBR):

• Rapid price drop (Drop) indicates excess supply.
• Price consolidates and forms a base (Base).
• When buying momentum resumes, price breaks out upward (Rally).
• Traders can buy at breakout points.

Supply Zone Rally Base Drop (RBD):

• Rapid price rally (Rally) indicates excess demand.
• Price consolidates and forms a base ###Base(.
• When selling momentum resumes, price breaks down )Drop(.
• Traders can sell at breakdown points.

) Trend Continuation Trading (Continuation)

Rally Base Rally RBR - Uptrend continuation:

• Price rises, consolidates, then continues upward.
• Demand remains strong.

Drop Base Drop DBD - Downtrend continuation:

• Price drops, consolidates, then continues downward.
• Supply remains strong.

Summary and Practical Application

Demand and supply underpin all price movements, whether in commodities, services, stocks, or financial assets. Investors and traders who understand these principles gain an advantage in forecasting and decision-making.

Key takeaway: Increasing demand + decreasing supply = rising prices; decreasing demand + increasing supply = falling prices.

By studying and testing with real price data, investors can gradually improve their understanding and effectively incorporate these principles into their market analysis.