Supply and demand zones represent areas on a chart where significant buying or selling pressure exists. Unlike traditional support and resistance, these zones focus on the underlying market dynamics that cause price reversals. Understanding supply and demand can transform how you approach market analysis.
What Are Supply and Demand Zones?
Supply zones are price areas where sellers overwhelm buyers, causing price to drop. Demand zones are areas where buyers overwhelm sellers, pushing price higher. These zones form when large institutional orders cannot be filled at once, leaving unfilled orders that act as magnets for future price action.
Key principle: Supply and demand zones are not just lines on a chart. They represent real institutional order flow where banks and large traders accumulated or distributed positions.
Supply vs Resistance: The Key Difference
Traditional resistance is drawn at price highs. Supply zones focus on the origin of the move down, not the high itself. This subtle but important distinction means:
- Resistance: The peak price where selling occurred
- Supply zone: The consolidation area before the aggressive move down
- Better entries: Supply zones often give earlier entry points
- Cleaner stops: Stops can be placed just above the zone
How to Identify Demand Zones
Demand zones form when price consolidates before making an aggressive move higher. Look for these characteristics:
1. Strong Departure
The move away from the zone should be strong and impulsive. Multiple large bullish candles indicate institutional buying. Weak departures suggest weak demand.
2. Basing Pattern
Before the move, look for a small consolidation or basing pattern. This base represents accumulation where large orders were being filled.
3. Minimal Time in Zone
Strong demand zones see price spend minimal time before departing. Extended consolidation may indicate the zone has already been tested multiple times.
Demand Zone Example
AAPL consolidates between $175-176 for three candles on the hourly chart.
Suddenly, price explodes higher with three consecutive bullish candles, reaching $182.
The $175-176 range is now a demand zone. When price returns to this area, expect buyers.
Traders look to buy near $175-176 with stops below $174.50.
How to Identify Supply Zones
Supply zones form when price consolidates before making an aggressive move lower:
1. Sharp Drop
The decline from the zone should be sharp with large bearish candles. This indicates institutional selling pressure.
2. Distribution Pattern
Look for a small range or consolidation before the drop. This represents distribution where institutions were selling.
3. Gap Downs
Sometimes supply zones form with gap downs, creating an even stronger zone as unfilled orders remain above.
Supply Zone Example
NVDA rallies to $480 and consolidates between $478-480 for several hours.
Price then drops sharply with heavy volume, falling to $460 over two days.
The $478-480 range becomes a supply zone. When price rallies back, expect sellers.
Traders look to short near $478-480 with stops above $482.
Zone Quality: Fresh vs Tested
Not all supply and demand zones are equal. Zone quality matters:
Fresh Zones
- Never been retested since formation
- Higher probability of reaction
- More unfilled orders remaining
- Best trading opportunities
Tested Zones
- Price has returned and reacted once or more
- Some orders have been filled
- Weaker with each subsequent test
- Consider the strength of each reaction
Rule of thumb: Zones weaken with each test. A fresh zone is stronger than one tested twice. After three or more tests, the zone may be exhausted.
Trading Supply and Demand Zones
Entry Strategies
There are several ways to enter trades at supply and demand zones:
- Limit orders: Place limit buy orders at demand zones, limit sell orders at supply zones
- Confirmation entry: Wait for price action confirmation at the zone before entering
- Scaled entries: Enter partial positions at multiple levels within the zone
Stop Loss Placement
- Place stops beyond the opposite end of the zone
- Add a small buffer to account for false spikes
- Avoid stops that are too tight within the zone
Profit Targets
- Target the opposite zone type (demand zone target = next supply zone)
- Use the origin of the move as a minimum target
- Scale out at multiple zones for better risk management
Timeframe Analysis
Supply and demand zones exist on all timeframes. Higher timeframe zones are more significant:
- Monthly/Weekly: Major institutional zones, high impact
- Daily: Swing trading zones, strong reactions expected
- 4-hour/1-hour: Day trading zones, good for intraday trades
- Lower timeframes: Scalping zones, quicker but smaller reactions
Combining with Other Analysis
Supply and demand zones work best when combined with:
- Trend analysis: Trade demand zones in uptrends, supply zones in downtrends
- Volume analysis: Confirm zones with volume spikes at formation
- Market structure: Zones at higher highs/lows carry more weight
- Economic events: News can invalidate or strengthen zones
Common Mistakes to Avoid
- Drawing too many zones: Focus on the clearest, most significant areas
- Ignoring zone quality: Fresh zones are stronger than tested ones
- Wrong timeframe: Match zone timeframe to your trading style
- No confirmation: Blindly buying/selling at zones without price action confirmation
- Fighting the trend: Trading demand zones in strong downtrends or supply in strong uptrends
Track Your Supply and Demand Trades
Pro Trader Dashboard helps you analyze your zone-based trades and identify which setups work best for you.
Summary
Supply and demand zones represent institutional order flow areas where significant buying or selling occurs. Unlike traditional support and resistance, these zones focus on the origin of moves rather than just highs and lows. Fresh zones offer the best opportunities, while tested zones weaken over time. Combine supply and demand analysis with trend direction and volume confirmation for the highest probability trades. Always use proper stop loss placement and trade in the direction of the larger trend for best results.
Learn more: support and resistance basics and order blocks trading.