Supply and Demand
Supply and demand. These are the two components of any economic construct. They are very simple terms to understand. Supply is the availability of something while demand is the need. In any market, there are 4 basic stages. High supply and high demand, high supply and low demand, low supply and high demand, low supply and low demand.
HIGH SUPPLY AND HIGH DEMAND In this economic stage we have a product that is readily available, or easily acquired. We also have a lot of need or desire for that product. This leads to a fairly balanced market where value is equally derived from the producer and the consumer. The balance in this market translates to fairly stable price transactions. There is not a lot of volatility or change in the price from transaction to transaction making things fairly predictable.
HIGH SUPPLY AND LOW DEMAND In this economic stage we have a product that is readily available (or easily acquired) but we don’t have a lot of need or desire for the product. This would be considered an unbalanced market, where value is not agreed upon by the producer nor the consumer. In this type of market, price needs to move to an area where the consumer determines that value meets the need or desire. This typically causes the price of a product to move lower until it finds an area of acceptance.
LOW SUPPLY AND HIGH DEMAND In this economic stage we have a product that is hard to find (or not easily acquired) but we have a lot of need or interest in the product. Similar to the high supply and low demand stage, when we are in a low supply and high demand stage the market is again unbalanced. The producers and consumers no longer agree on value. Ultimately price will move higher as the need outweighs the supply. The greater the need coupled with the longer they have to wait, this increases the price of a product.
LOW SUPPLY AND LOW DEMAND In this economic stage we have a product not readily found or acquired, nor is it needed or desired. Like the first stage we discussed, this market is balanced. Producers and consumers have agreed on the value allowing for consistent, predictable pricing to occur.
Understanding these four stages that exist in any tradable market can give you an idea of where you are in that market, and where you might be heading. Let’s look a little closer at two market stages: high supply/high demand and low supply/low demand. Earlier I stated that both markets are fairly balanced. I also stated that with low supply/low demand no one has it and no one wants it, while in a high supply and high demand market everyone wants it and everyone has it. The one thing that differentiates these two stages is VOLUME.
So if you are in a market where price is fairly stable, consistent and predictable, but you have very little in regards to volume (i.e., not a lot of transactions), you are in a low supply, low demand market. If you are in a similar market but you have a lot of volume (i.e., loads of transactions), you are in a high demand, high supply market. This type of market is the precursor to the other two markets we discussed. This high volume, stable and balanced market will remain until there is a shift in balance either in supply or demand. The minute balance is shifted to high supply, price will move to price discovery at lower levels. The minute balance is shifted to high demand, price will move to price discovery at higher levels. In stock trading, identifying these high supply, high demand areas open opportunities for profit when the market balance shifts into unbalanced condition. Having a thorough understanding of price action and volume can give you the edge in determining these levels and help increase your odds of success. This is why I believe that price and volume rule the markets.