Supply and Demand vs Support and Resistance

The difference between supply and demand vs support and resistance

Support and resistance is a level where traders see a lot of failed attempts at which prices cannot surpass - this idea is familiar to most traders. Supply and demand is a much deeper zone that represents regions of key price levels of broad support and resistance.

How to use support and resistance to trade supply and demand

Trading Supply and Demand

The first thing traders need to do before placing a trade based on supply and demand is to decide whether the environment is expected to stay the same or to rapidly change. This can be assessed by market volatility measures such as significant political strife or economic news. This is the dichotomy between the decision to trade for a range or trade for a breakout.

Trading the Range

When trading a range, traders are anticipating the environment to stay about the same; with support or resistance standing its ground allowing for traders to ‘buy low,’ and ‘sell high’. The chart below illustrates how a trader can use price alone to identify those points in the market at which demand begins to outstrip supply (creating increased prices) or supply begins to overrun demand (creating decreased prices).

Trading the range with a GBP/USD chart

Trading the Breakout

The other side of the coin is the trader that is expecting the environment to change, with breaks of support or resistance to create new highs or new lows.

With this style, the trader‘s objective changes from the range-bound condition. The goal is now to ’buy high, and sell back at a higher price,‘ or to ’sell low and buy back to cover at a lower price.

Trading the breakout with a EUR/USD chart

Since these environments can be considerably more chaotic than what might be expected in ‘ranging’ markets, traders are usually best served by altering the risk management condition to account for the increased risk of trading in a rapid market. For more information, read our guide to forex risk management techniques.

What are psychological levels and how do they work？

Psychological levels are market price levels which are often key levels in forex denoted by round numbers. These round numbers frequently act as levels of support and/or resistance.

Psychological support and resistance consistently work because of fundamental human disposition. Human beings value simplicity; from a trading perspective this means valuing whole numbers. Traders often use these numbers as entry, exit or stop levels. These stops and limits can alter order flow and price changes.

Identifying psychological levels on forex charts

Traders will often call these whole number intervals ‘double-zeros,’ as these prices are at even numbers such as 1.31000 on EUR/USD, 1.57000 on GBP/USD or 132.00 on GBP/JPY. The chart below identifies the ‘double-zeros’ on the current USD/JPY chart.

Some traders will take this a step further by looking at the number directly in the middle of these whole numbers or ‘the fifties.’ These levels, such as 1.31500 on EUR/USD or 131.50 on GBP/JPY can often come into play in the same manner as the ‘double-zeros.’

Traders will notice that there will often be some element of congestion at these key levels in forex as prices move up or down. The chart below illustrates USD/ZAR with ‘fifties’ denoted.

Notice that many of the price swings on the above chart take place around one of these levels. Therefore, traders want to incorporate these levels into support and resistance revisions. The chart below represents the initial USD/JPY chart with identified swing levels.

Consequently, these prices act as a psychological line which work well as support and resistance. Not every one of these prices act as a function of support or resistance, but enough do that these levels warrant the traders attention.

How to use psychological levels in forex trading

AUD/JPY weekly chart

On the AUD/JPY chart above there are six strong inflections off the 75.00 price level. Each time price approached 75.00, the currency pair bounced back up. This is because:

Traders saw the price of 75.00 and believed this is cheap which prompted long AUD trades off this level.

As traders were opening short positions, profit targets were set at an even 75.00. This profit target order to close positions created demand in the market (traders were buying to cover, and this buying interest is considered ‘demand’).

After the first inflection, traders may not have been extremely bullish on the prospect of pushing price much lower than 75.000 as this price has already been exhibited as support.

In many ways, untested ‘psychological’ levels can be looked at like pivot points. An area where there maybe some element of support or resistance.

In general, round numbers such as 70.000 on AUD/JPY or 1.0000 on AUD/USD will garner more attention than a more pedestrian level like 71.000 on AUD/JPY. Most traders will often assign a higher degree of strength to the more rounded-intervals.

Where traders can really find value with these levels is when prices may have resisted or been supported there in the past. This tells the trader that others are noticing and acting on those prices, and the potential for the ‘self-fulfilling prophecy’ of technical analysis may potentially be considered with more strength.

Advantages and limitations of psychological levels

Key levels in forex should be assessed in line with the current trend and whether there is secondary technical suggestions in favor of the trade. Below are the advantages and limitations of psychological levels: