Supply and Demand Patterns – Reversal and Continuation patterns

Supply and demand are a foundational and fundamental concept used in economics and trading. In trading markets, the concept of supply and demand refers to price movements influenced by the balance between buyers and sellers. Trading imbalances in financial markets requires the ability to spot supply and demand zones.

Trading valid supply and demand zones are highly dependent on understanding supply and demand patterns. This article explores understanding of Supply and Demand patterns, types (reversal and continuation patterns), and identification of Supply and Demand zones.

Understanding of Supply and Demand Patterns

Understanding and predicting price movement is a bit difficult task. However, this task is accomplished with the help of price action patterns. Trading patterns are price movement on chart that appear again and again on chart. These price action patterns reflect market behavior. Traders use the patterns to predict potential future market behavior.  These patterns are categorized into continuation and reversal patterns.

Supply and demand patterns are somewhat similar to normal price action pattern. However, these patterns are related to trend continuation and reversal. Reversal patterns of supply and demand form when there is a change in trend. This change of trend takes place either from an uptrend to a downtrend or from a downtrend to an uptrend.

In continuation patterns, in downtrend, market falls and then go sideways for a while for testing. This base is the supply area because then market continue its downtrend. In an uptrend, market moves up and go sideways for a while. This is a testing period of demand. After successful testing, market continue its prior trend. In general, continuation patterns indicate that the ongoing trend will likely to continue in future.

Price action patterns and supply and demand pattern are formed by market psychology. These patterns represent collective decision making by traders. Supply and demand patterns are used to spot supply and demand zones. Recognizing these patterns can help traders identify key entries and exit points. This helps us to manage risk properly by placing stop-loss and take-profit targets.

Types of Supply and Demand Patterns

There are two types of supply and demand patterns:

• Reversal patterns
• Continuation patterns

Reversal Pattern of Supply and Demand

Reversal patterns in supply and demand indicate shift in market trend. Market shift its trend either from an uptrend to a downtrend or from downtrend to an uptrend. These are foundational in supply and demand trading because these patterns can be used to identify potential turning points in the market.

There are two key reversal patterns in supply and demand trading. These patterns include Drop-Base-Rally (DBR) and Rally-Base-Drop (RBD).

Drop-Base-Rally (DBR) begins with a downtrend. At first sellers dominate and push prices lower. Eventually, the price stabilizes and forms a base (little sideway movement). In this time period, volatility reduced and price test supply and demand. From this base, demand increases and buyers regain control. This leads to a strong rally upward, marking start of an uptrend.

Rally-Base-Drop (RBD) begins with an uptrend. At first buyers dominate and push price higher. Eventually, the price stabilizes and forms a base. In this time period, volatility reduced, and price tests supply and demand. From this base, supply increases and sellers regain control. This leads to a strong rally in downward direction, marking start of a downtrend.

Continuation patterns of Supply and Demand

Trading an ongoing trend is seen as a difficult task. Most of the time we fear of trend reversal. Continuation patterns occur in an ongoing trend. Continuation patterns indicate areas where market pauses briefly. This allows traders to identify potential entry points that are inline with the prevailing trend.

There are two continuation patterns: Drop-Base-Drop (DBD) and Rally-Base-Rally (RBR).

Drop-Base-Drop (DBD) is a bearish continuation pattern. In this pattern, price moves downward (drop), then market moves sideways for a while which is called base. This is a zone of price action in which selling and buying temporarily balance. After this pause, sellers regain control and price continue its decline by creating another sharp drop. This base represents supply areas. Traders wait for the price to retest the area for selling opportunities.

Rally-Base-Rally (RBR) is a bullish continuation pattern. In this pattern, price moves upward (rally), then market moves sideways for a while which is called base. This is a zone of price action in which selling and buying temporarily balance. After this pause, buyers regain control and price continue its upward movement by creating another sharp rally. This base represents demand areas. Traders wait for the price to retest the area for buying opportunities.

Final Note

Supply and demand patterns are valuable tool in understanding price action. Reversal patterns signal trend changes, while continuation pattern indicate trend continuation. Having an understanding of these zones helps traders anticipate price movements. This helps them refine entry and exit points. These patterns can be used along side other technical tools like volume analysis.

Trading financial markets involves significant risk and may not be suitable for all investors. Supply and demand patterns can help us in crafting trading strategies but do not guarantee success in trading. Market conditions can change rapidly. Traders should use proper risk management strategies. Place your stop-orders and position sizing. Past performance of any trading strategy does not ensure future results.

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