The principles of supply and demand are universally applicable, extending to various industries and businesses, including the foreign exchange market.

supply and demand

Who do you think is controlling prices in the forex market? is it a broker? big banks? some billionaires? No, they, just like you, are players. It is true that they have bigger bargaining position than us retail traders, but they do not have sufficient power to determine prices every time. What moves the forex market is supply and demands.

 

The Importance of Supply and Demand

Supply and demand are fundamental factors that significantly impact the forex market. The interplay between supply and demand is crucial as they mutually influence each other. They directly influence the prices of forex pairs. When supply exceeds demand, it often leads to lower prices. Conversely, when demand surpasses supply, prices tend to rise due to limited availability.

Understanding the dynamics of supply and demand is essential for traders. By monitoring and analyzing these factors, traders can make informed decisions before they jump into the market. A balanced equilibrium between supply and demand fosters a healthy and efficient market, ensuring that currencies are adequately available to meet traders' needs and preferences.

 

How Supply and Demand Happen

The supply and demand zone will look like this on the chart:

supply and demand

There are always two forces at play in the market at any time. Prices will move according to which side is winning in strength. Just like a tug of war where people who lose out on strength will be dragged through the mud, so does either the supply or the demand side of the market. These forces are also the ones who create support and resistance.

When there is more supply than demand, surely prices will go down. But when there is more demand than supply, even prices will go up. Using the same logic, if prices have become too expensive, then demand will start to go down. Contrarily, when prices have lowered, then people may consider buying it. 

This is also the reason why monetary authorities (ie. central banks) is considered the biggest player in the forex market and are known to be extremely influential toward currency appreciation and depreciation.

Monetary authorities are provided with huge amounts of financial resources in order to fulfill their responsibility to balance the country's macroeconomic condition through the use of monetary policies that at the same time will change the country's money supply along with several other measures.

 

Using Supply and Demand to Trade with the Trend

As market players with extremely small power, we don't have the strength needed to change the direction of the market once it is decided. Hence, there are many who suggested traders to never go against the trend, or else go to the other side by using divergence. Hence, one of the must-have abilities that should be learned early by any beginner trader is reading the trend.

While identifying trends in a long-term chart is relatively easy as any bullish, bearish, and sideways can be seen clearly, identifying trend in a shorter time frame needs more work by utilizing technical indicators.

Furthermore, in accordance with market mechanisms, there usually are certain price levels at which prices are considered too high or too low. If it is too high then prices will fall, and if it is too low then prices will bounce back.

support resistance

These are what makes support and resistance level on the chart. Support and resistance for past prices are visible in the chart, but to determine future prices' possible support and resistances, traders should also employ technical indicators. Knowing future prices' possible support and resistances will go a long way to help traders detect correct entry and exit levels.

In the application of supply and demand understanding, there are also traders that make use of volume-related indicators and sentiment-measuring tools. Volume tells how many assets traded from time to time, thus providing information about the strength of price movement. It can also be a leading indicator as a bullish move is oftentimes preceded by rising volume and ranging markets usually have extremely low market participants and trading volumes.

 

Who Causes the Change in Supply and Demand?

Firms, households, and investors who engage in transactions to buy or sell foreign goods, services, and assets cause supply and demand shifting. These transactions require the exchange of currencies. For instance, households may purchase imported goods using foreign currency for payment. Similarly, individuals and businesses may invest in foreign countries, requiring the acquisition of foreign currency.

Exchange rates represent the prices of foreign currencies and are determined in the respective foreign currency markets. Numerous factors can influence these exchange rates, including the levels of imports and exports, GDP, market expectations, and inflation. For instance, if the United States enters a recession, its GDP declines, reducing imports from Mexico. Consequently, the demand for Mexican pesos decreases, leading to a depreciation of the US dollar relative to the Mexican peso. In other words, the Mexican peso gains value.

 

Conclusion

So, now you know how important it is a simple understanding of supply and demand in the forex market is for traders. This is, of course, is just the beginning. A deeper understanding of it can lead to practical application during trading and the development of trading strategies. Many strategies are derived from this, be it technical or fundamental-based.