Understanding "Supply" and How to Apply It in Investing

If you’ve ever wondered how stock or product prices in the market change, the answer may lie in two ancient yet powerful economic concepts: “Supply” and “Demand.” Although fundamental, they are powerful tools for predicting market directions.

What is Supply? - The Willingness to Sell from Sellers

“Supply” refers to the quantity of goods or services that sellers are willing to offer at various prices. Contrary to what many think, supply doesn’t mean the total amount of goods in the market but reflects the willingness of sellers to sell at different price levels.

When plotting the “Supply Curve” on a graph, each point indicates how much sellers are willing to supply at a specific price. The supply curve can also indicate the minimum price at which sellers are willing to supply a given quantity.

The Law of Supply

The law of supply describes a direct relationship between price and quantity supplied: as prices rise, sellers tend to supply more because profits increase. Conversely, when prices fall, sellers reduce the quantity they supply because profits are less attractive.

Factors Affecting Supply

Beyond price, other factors influence supply levels, including:

• Production costs: Higher costs may lead producers to reduce output.
• Technology: New technology often allows for increased production at lower costs.
• Number of producers: More producers entering the market increase supply.
• Future price expectations: If sellers expect higher prices later, they might delay selling now.
• Natural disasters and environmental factors: These can hinder production.

What is Demand? - The Push from Buyers

If supply comes from sellers, demand comes from buyers, representing the quantity of goods that consumers want and are willing to pay for at various prices.

The “Demand Curve” shows the inverse relationship between price and quantity demanded: high prices = lower demand; low prices = higher demand.

The Law of Demand

This relationship is driven by two main effects:

Income Effect: When prices decrease, consumers feel wealthier and can buy more.

Substitution Effect: When a product becomes cheaper, consumers tend to substitute it for more expensive alternatives.

Other factors influencing demand

• Consumer preferences: Trends can shift demand.
• Prices of related goods: Substitutes or complementary products.
• Number of consumers: Larger populations increase demand.
• Consumer confidence: A strong economy encourages more purchases.

When Does “Supply” Change in the Market?

In financial markets, asset supply can change for various reasons, such as:

Company policies: A listed company may decide to issue new shares, increasing supply, or buy back shares, reducing supply.

New IPOs: New companies entering the market bring additional shares, increasing supply.

Market regulations: Rules like the Silent Period after IPOs restrict large shareholders from selling.

Market liquidity: When foreign capital flows in, demand increases, and sellers may offer more shares.

How Do Demand and Supply Interact to Determine Price?

The actual market price is at the “Equilibrium” point where the demand and supply curves intersect—where buyers’ and sellers’ quantities match.

Why does the price tend to stay at this point?

• If the price is above equilibrium: Sellers want to sell more, but buyers want to buy less, leading to excess supply and downward pressure on price.
• If the price is below equilibrium: Buyers want more, but sellers are reluctant to sell, causing shortages and upward pressure.

Thus, prices are constantly pushed toward the equilibrium level.

Investors Use “Supply and Demand” to Predict Price Changes

Fundamental Analysis

In fundamental analysis, many associate supply with the number of shares, but actual decision-making—like issuing or buying back shares—affects demand more significantly.

For example:

• Good earnings reports (positive news) increase demand; investors are willing to pay higher prices.
• Announcements of share dilution (more shares issued) may cause investors to hold back, reducing demand and potentially lowering prices.

Technical Analysis

In technical analysis, supply and demand are reflected through price movements and trading volume:

1) Candlestick Analysis

• Green candles (close > open): Buying pressure dominates, indicating strong demand.
• Red candles (close < open): Selling pressure dominates, indicating strong supply.
• Doji (open ≈ close): Balance between buyers and sellers.

2) Trend Analysis

• Higher highs and higher lows: Demand is strong; prices likely to rise.
• Lower lows and lower highs: Supply dominates; prices likely to fall.
• Sideways movement: Supply and demand are balanced; waiting for new signals.

3) Support and Resistance

• Support: Price levels where buyers tend to step in, preventing further decline.
• Resistance: Price levels where sellers are eager to sell, preventing further rise.

Demand Supply Zone - Practical Trading Application

“Demand Supply Zone” is a trading technique that identifies points where supply or demand has been exhausted, then waits for price to return to these zones to enter trades.

Reversal Patterns

DBR (Drop Base Rally): Price drops → consolidates → rallies again

• Excess supply (over-supply)
• Buyers step in at low prices
• Price consolidates
• Positive news triggers demand, price breaks upward
• Traders buy at breakout

RBD (Rally Base Drop): Price rises → consolidates → drops again

• Excess demand (over-demand)
• Sellers enter at high prices
• Price consolidates
• Negative news triggers supply, price breaks downward
• Traders sell at breakdown

Continuation Patterns

RBR (Rally Base Rally): Price rises → consolidates → continues upward

• Strong demand persists
• Consolidation followed by renewed buying interest
• Price continues upward

DBD (Drop Base Drop): Price drops → consolidates → continues downward

• Strong supply persists
• Consolidation followed by renewed selling
• Price continues downward

Summary

What is supply? It’s not just the total quantity of goods but reflects the willingness of sellers to sell at various prices. It’s one of the two main forces—along with demand—that determine prices.

Traders and investors, whether using “fundamental” or “technical” analysis, incorporate supply and demand concepts to forecast price directions.

Understanding supply and demand is not only about studying theories but also about practicing with real market data to develop an effective, practical perspective.