The following article aims to provide information regarding:
- Why "Supply and Demand" is so different from the "support and resistance" that novice traders know and use
- Some examples why "support and resistance" with the various indicators and oscillators is completely arbitrary
- Why true "Supply and Demand" levels go hand in hand with the probabilities of your trades
"Supply and Demand" is the only true form of “support and resistance”
One of the most basic, yet so misunderstood concepts, is that of the comparison between “Supply and Demand” and “support and resistance”. If we said that "Supply and Demand" is the only true form of “support and resistance” we might confuse some people even more, so let’s skip directly to the explanation.
The “support and resistance” most traders know is some form of a completely arbitrary price like the one suggested by a moving average, or the one suggested by some oscillator, indicator, or other form of arbitrary calculation. We call these "arbitrary" calculations because they actually are. Imagine that you set up your favorite moving average(s) and wait for some trigger, like change of direction or a crossover and so forth. The trigger you are waiting for will happen at completely different prices depending on the parameters of the setup of your moving average. Change these (arbitrary) parameters and you will arrive at a completely different but equally arbitrary result. Even the “common” parameters like 200 candles for an EMA (exponential moving average), are completely arbitrary. Being common does not make them any less arbitrary. This applies to ALL kinds of indicators and oscillators that have ever existed, not only in forex but in any other market and trading platform.
In addition to the above, if you ask different traders what do they consider support and resistance, each one of them will tell you one of a billion different contradicting things. One trader’s support will coincide with another trader’s resistance. Someone will believe that a moving average holds some kind of power that turns price around, someone else will say the piercing of Bollinger bands in this or that way predicts this and that, while someone else will be absolutely convinced that his magic oscillator shows where price is overbought or oversold and thus can accurately predict a reversal with actionable accuracy, or that his indicator can apparently predict the future by monitoring the results of some very complicated calculations, even if based on completely arbitrary sets of parameters. Not to mention all those thousands of mystical patterns with fancy names that can be found in trading textbooks sold at your local bookstore. The madness doesn’t even stop there as then you have the myriads of combinations of all the above, chosen specifically for their exceptional "supernatural" ability to predict (or at least "indicate") the future, even better than a magic crystal ball! So the above can give you an idea of what the “support and resistance” madness is, and why there are as many versions of it as there are traders using it. And we have only covered a tiny part of what can be considered as "support and resistance", the complete list is beyond the scope of this article but you get the point. There are nearly as many versions (and prices) of "support and resistance" as there are traders, and although some of them choose to use popular variants of the above, these are equally arbitrary and equally unreliable.
Ask any number of astute “Supply and Demand” traders what they consider support and resistance, and they will all point to the same areas on the chart where a previous supply/demand imbalance left its traces on the chart
But ask any number of astute “Supply and Demand” traders what they consider actual support and resistance to be, and they will all point to the same areas on the chart where a previous supply/demand imbalance left its traces on the chart and which remains untouched by price to this day, thus being capable of creating a predictable market reaction when/if price returns to the imbalance level. Of course there might be some slight difference in their methods or to the strictness they prefer to apply during the filtering of their candidate levels, but the core understanding of what Supply and Demand traces look like on the chart and how they can be used profitably on a consistent basis will be quite uniform. Frequently you will also realize that successful Supply and Demand level traders prefer not to use any indicators or oscillators at all. There are specific reasons for this (discussed on a separate page), although it all boils down to the fact that adding any sort of arbitrary thinking to the mix only reduces the clarity with which you see the market. In any case, Supply and Demand trading is based on anticipation and so any form of confirmation only adds lag and risk to the trade setup.
But if a Supply and Demand level which fulfills the filtering (evaluation) criteria wasn’t usable and actionable information, it wouldn’t be of much value. What makes it valuable is the fact that once someone starts recognizing the various possible levels and can also properly filter them in order to arrive to the ones that have the potential to turn price around (or at least cause a nice bounce off the level), he can use these levels for that which every trader strives for: the low-risk entry with the high-probability reward. And both parts are equally important.
Low-risk entry means entering the market when the probabilities are stacked on your side
A low-risk entry trade can give you a huge benefit compared to any other trade entry. A low-risk entry, in this context, means entering the market when the probabilities are stacked on your side, usually resulting in the trade quickly giving you the opportunity to grab at least a partial profit while even putting your stop for the rest of the position at the break-even point, if not better. Depending on the trade setup and its expected duration, many strategies can be applied, including swing trading or longer term position trading, but they will all have a low-risk entry as a start, that’s the benefit you get by knowing the proper levels and using them while trading on any timeframe, but even more so on larger timeframes like 1H or 4H.
As Forex traders, we can never have access to the orders of the entire planet, let alone the fact that most of them are not even limit orders sitting on a server but are either in someone’s mind, or shielded behind stealth software making them transparent to the rest of the market. But let’s imagine for a moment that we had access to all this information, and so we could see that e.g. there were some huge orders waiting to buy between 1.2330 and 1.2350, if/when price declined to that level. If we could have access to this kind of information, we wouldn’t need much else in order to trade successfully and with minimal risk. We would simply place our buy orders just above the demand level and we would place our stop order below the demand level, thus not only putting a strong barrier between our entry and our stop order, but also using a force that is capable of turning price direction around in our favor.
As soon as price declined to the range of the demand level, the last sellers would get their orders filled by the exceeding demand at that level, meaning price would be where demand greatly exceeds supply. Price would have to at least bounce off the level, and depending on how large the supply/demand imbalance is, it could possibly even reverse direction and continue upwards until supply greater than the demand is met. Make no mistake, this is the ONLY OUTCOME which is MATHEMATICALLY POSSIBLE, for however long the Supply/Demand imbalance lasts. That's why we only trade the first return of price to the level when the imbalance is still as great as it can be for that level and probabilities are still stacked on our side of the trade.
Make no mistake, this is the ONLY OUTCOME which is MATHEMATICALLY POSSIBLE, for however long the Supply/Demand imbalance lasts
This does NOT mean that it is impossible for the level to fail, but it means that in order for the level to fail new supply which is greater than the demand in the level would somehow have to emerge, and the chances of that happening are much lower than the opposite. By trading such a Supply/Demand level the proper way, you would be trading with probabilities stacked on your side of the trade.
In contrast, trading some kind of support or resistance area as known and used by the masses would offer you absolutely no edge against your competition. You would be trading where everyone else trades, and you would be slowly (or quickly) losing your capital to someone on the other side of the trades. Remember, if you cannot spot the novice trader on your charts, then most likely you are the novice trader.
Remember, if you cannot spot the novice trader on your charts, then most likely you are the novice trader
Although this is discussed in more detail elsewhere, to give you a quick hint here, a trader who buys right below a large Supply level or a trader who sells right above a large Demand level is a good example of a novice trader. You can assume with a certain degree of confidence that this trader would probably be following the prediction of some indicator or oscillator, or simply using any other equally arbitrary way of determining the correct time and price for an entry instead of using more objective market information.
We provide you with our own identified levels in advance so that you can use them in your trading, and if you also desire to learn in much more detail how to recognize, filter, and use such levels on your own you have this opportunity too. The free educational material on our site is a very good start, and don't forget that as you watch more and more market reactions to pre-identified Supply and Demand levels, it will become much more apparent how you can use them in order to stack the probabilities on your side so as to achieve long term profitability.