We’ve all heard the term “supply and demand” – but how do you actually draw those zones on a chart? Are there rules to follow, or is it just a matter of personal preference? Today, we’ll investigate the tried-and-true ways of drawing supply and demand zones that can help you reap profits no matter what the market is doing.
How to Pinpoint Demand & Supply
Drawing supply and demand zones requires you to identify where excess demand or supply starts to significantly outweigh prevailing demand or supply levels. Consequently, the key to success lies in gleaning those areas where buyers or sellers dominate the market. Here’s how to do it:
- Look for a trend on the chart; when the price is increasing, you’re dealing with demand, and when decreasing, it’s supply.
- Build trendlines that connect two or more price lows in the case of a demand zone and two or more price highs when dealing with a supply zone.
- For a better accuracy, wait until the price test the trendline multiple times.
- Mark the top of the supply zone and the bottom of the demand zones.
- Keep an eye on both zones and take a position when price retraces or touches them again.
How to Utilize Supply & Demand Zones
Once you’ve identified the zones properly, you can start using them to your advantage. You see, supply and demand zones can provide traders with some excellent opportunities to take profitable trades. For example, when the price touches a supply zone you can consider a short trade, and when it touches a demand zone a long trade is in order.
The bottom line is to enter the trade when price retests the support or resistance areas and plan your exits accordingly. Take profit orders above the demand zone in the case of buying and below the supply zone when shorting. But don’t forget to respect your stop loss level too; it’s the most important risk management tool you have.
Tips For Drawing Supply & Demand Zones
While supply and demand can narrow it down to specific price levels, there’s still a certain element of discretion involved in drawing zones. But the good news is that anyone can improve their skills with a few top strategies.
- Look for multi-year high or low zones where price respected the area multiple times.
- Be patient and wait for the price to test the area frequently before drawing a line.
- Know where to draw your supply or demand zone when price approaches a trendline.
- Build mental files of the levels you come across and review them regularly.
- Always consider the overall trend and determine if it will benefit your trades.
Risks Associated with Supply & Demand Zones
There are a few potential risks associated with drawing supply and demand zones that can significantly impact your trading profits. First, there’s the risk of entering too late, i.e., when the price has already reversed from the supply and demand zones. This way, you’re trading in the opposite direction of the move and thus increasing the risk of whipsaws.
Another risk worth mentioning is relying too much on the supply and demand approach. If you overtrade it or have poor risk management, you can easily end up with large losses that can quickly deplete your trading account.
The Bottom Line
Supply and demand zones offer one of the most reliable technical indicators that you can use in any market conditions. As long as you have the basics down, like trendlines and price action, you’ll become an excellent supporter of your trading strategy.
