StockMarketSynergy

This lesson is a brief introduction to The Market Forces of Supply and Demand as seen through Volume Spread Analysis.


First, the basics from Investopedia:

Supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, therefore, is a reflection of supply and demand.

Markets move off of the imbalance of supply and demand. This is what VSA identifies so clearly on a chart: <i>an imbalance of supply and the market has to fall; an imbalance of demand and the market has to rise.

Accumulation from the Supply/Demand perspective is demand coming in to gradually overcome and absorb the supply and to support the market at this price level.

Distribution from the Supply/Demand perspective is where the Supply overcomes Demand and stops the upward move and eventually begins the downward move. Distribution refers to the elimination of a long investment or speculative position and often involves establishing a speculative short position by professional interests in anticipation of a decline of price. In the distribution area the professional investors or speculators who had previously bought stock, sell there stock to the public. The public buys and it generally buys because of good news of various sorts. Good news on the company, its product, the economy or any news which will entice untrained people to rationalize there buying decision. The best news of all is the advancing of the price of a stock.

There is an important relationship between supply/demand and price. But there are also other determing factors in a market. To illustrate: suppose brand new Fords are selling for $20,000. This means demand will step in for that commodity at that price. But, suppose, a Ford is being offered for less: $10,000. Just considering supply and demand, one would think that demand would grab it up.

Now lets consider some other factors. In the first instance we find that the the Fprds are all pickup being sold in a ranch community. While, in the second instance the Ford is ten years old and has been in a wreck. In this case demand might not step up at the offered price - or any price.

Now looking at the first case: The Ford dealer understood the communities expectations and supplied those expectations. In the second case, buyers were lkooking for a bargain, but expect to find something drivable at that price. There expectations were not met and, even though there was supply at their price, demand was never created.

For VSA to work, you must know the circumstances of the supply at a given price level and the expectations od demand at that price level.

Without any other considerations:

The Law of Demand states, the lower something's price is, the more demand there is for it and the relationship between demand and price is an inverse relationship. As one goes up, the other comes down.

The Law of Supply states, the higher something's price is, the more it will be supplied and the relationship between supply and price is a direct relationship. As one goes up, the other goes up.

Now consider the following chart:


There is nothing in the chart that hints at the reversal at point A. Price has passed a former demand zone and volume is regular. Then (B, the blue box) comes and area of consolidation lasting more than three weeks with tight spreads and slightly lower volume. Then, suddenly (C), volume is up and so is price. In a discussion on this at IFT, Tekmnd explains point C very well:

"Supply and demand is the basic foundation of economics However,...Supply and demand is the effect, not the cause.

Something happens, and supply increases or demand decreases (or both) causing price to go down, or something happens and supply goes down or demand goes up (or both) causing price to go up.

The "something" is the cause, and the change in supply/demand is the effect.

So, yes, price went up on USD/JPY because of an increase in demand for the pair. However, it is the cause for the change in supply and demand that caused the price change.

In fact, when you boil it all down, trading is the perception and speculation of what the change in supply and demand will be.

To put it another way, its not like a huge bunch of people coincidentally decided to buy this pair at the exact moment the Japan Central Bank makes an announcement that will cause the supply of Yen (the currency in circulation) to be increased by billions of Yen."
[I highly recommend his course at Free Forex Academy]

So, at point A the insiders (other banks in Japan) are told of the discount rate change coming and price shoots up on the dollar against the yen. At area B they wait for the public announcement, then price shoots up again at point C. There was a fundamental change that changed expectations that changed the balance of supply/demand and moved the price.


Wyckoff's third law: The Law of Cause and Effect

This law states that in order to have an effect you must first have a cause, and that effect will be in proportion to the cause. This law’s operation can be seen working as the force of accumulation or distribution within a trading range that works itself out in the subsequent move out of that trading range.

The idea is to measure this cause and project the extent of its effect. The excesses that develop in supply and demand are not random but are the result of key events in market action or the result of periods of preparation.


More from Tom Wiliams and becoming a Predator:
<i>Admittedly easy to identify in hindsight bar by bar. The important point is to keep in mind is that all the indications of weakness must have been there in the first place, as the market was unfolding day by day. You will no doubt have difficulties in analysing a chart as it unfolds bar by bar until you have trained your mind to think like a predator rather than run and act with the Herd. Practically all these up bars on this chart will be accompanied with 'good news' of some sort. If there is no good news available the news media will simply make it up to explain away the sudden up move taken place on any particular day. Your subconscious mind will be busy absorbing this information whether you like it or not and forming an opinion. To the untrained mind that view will be bullish, therefore you will not have even noticed volume implications telling you otherwise.</i>

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forexer

Transfer of positions from strong holders to weak holders at a loss to the weak holders. ( Distribution)

Transfer of positions from weak holders to strong holders at a gain to the strong holders. (Accumulation)

I also want to add on that price moves because of the changes in the intensity of demand and the availability of supply.


I seem to value every word Wycoff and TM said.

Forexer

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forexer

Hey Mike,

What's the charateristics of re-accumulation and distribution? What are their uses? Can you tell me more about them?

Forexer

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Magic

During the mark-up phase, sm may run low on supply or come to a previous level of resistance. Here they will stop the uptrend to test demand and gather more to sell (re-accumulate) - a retrace or short-lived consolidation. If it's an area of previous resistance, sm might need to risk a great effort on volume to get passed it - jump the creek. They won't do this unless they're relatively certain of success through testing.

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forexer

Thanks again.

Forexer

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