Introduction
Support and resistance is one of the first concepts new traders learn for any traded market, whether we’re talking about stocks, forex, crypto, options or metals. We know that price doesn’t move in one direction without bouncing off an area on a chart, often several times.
Support and resistance is a mysterious concept, as numerous factors cause it. But the simplest way of explaining it is supply and demand. Now, this is where the confusion comes in for many traders.
If supply and demand causes support and resistance, what’s the difference between support and resistance vs supply and demand?
Some chartists say they only trade support and resistance, while others trade supply and demand. For the most part, both are similar, but subtle differences do exist.
What is support and resistance?
It makes sense to look at each of these things individually before diving into the demand and supply vs support and resistance differences.
Support and resistance refers to the mechanism where certain levels on a chart act as obstacles stalling the price from moving beyond them.
The simplest way of thinking about support and resistance is that support is the ‘floor’ while resistance is the ‘ceiling.’
In a bearish trend, the ‘floor’ or support prevents the market from further down, causing retracement or minor reversal.
In a bullish trend, the ‘ceiling’ or resistance prevents the price from advancing further up, resulting in a retracement or minor reversal.
Support can turn into resistance, and resistance can become support in the future.
Here are chart images demonstrating what we’ve discussed.
The natural state of price in any instrument is to move in this zig-zag motion of impulses and corrections caused by supply and demand. But what exactly is this?
Let’s look at the second part of our support and resistance vs supply and demand discussion.
What is supply and demand?
Supply and demand is a trading strategy introduced by Sam Seiden, an experienced trader, writer and author, in the early 2010s. It’s based on several theories:
- Actual economic supply and demand (where demand is greater, prices rise; where supply is greater, prices fall; when both are equal, we have a range).
- Wyckoff’s accumulation and distribution
- ‘Smart Money’ concepts
What’s more practical to understand is that supply and demand is an advanced form of support and resistance. It is about looking for zones where there were past rallies and advance, and anticipating the same will happen in the future.
The supply zone is a resistance area where there is high selling interest, while a demand zone is a support area where there is high buying interest.
So, what causes supply and demand? Like many other things in trading, we have theories. The most commonly accepted one is how Smart Money (i.e., large financial institutions) places orders.
These guys trade massive volumes, making it difficult to meet the demand or supply. Remember, you need a buyer for every seller and a seller for every buyer.
For instance, if a bank decides to purchase 100 lots of a forex pair, there must be an opposite trade (sell) to finalize the transaction. If this doesn’t happen, the price will shoot up and look for orders on the way to fulfil the volume.
The problem is that this results in a partial fill, meaning that the Smart Money doesn’t get the full 100 lots at their initial price. This, of course, means less profit. So, one way is to execute the position in smaller chunks around more or less the same zone.
The hope is that enough sellers will be present at that zone once the price returns to it. When this happens, the Smart Money can place the remainder of their order and make more money with the eventual rally.
Supply and demand vs support and resistance: the differences
Now let’s explore the main distinctions in the support and resistance vs supply and demand comparison.
Historical significance
Supply and demand traders emphasise a zone’s newness more than how it has performed in the past. On the other hand, we only conclude support and resistance after the market has returned to it at least once before.
Although there are many types of supply and demand zones, they all develop along with the chart with little to no historical context. There’s a reason for this.
Supply and demand traders have long argued about the effectiveness of so-called old zones. Sam Seiden said that the longer the market has been away from a zone, the more powerful it becomes.
Yet, the opposite is often true; newer zones have a higher probability of causing a turning point. Again, it’s all market psychology theory. But the idea revolves around urgency. Smart Money wants their orders executed as soon as possible.
The longer the price has been away from a zone, the less interest it generates. Now, this isn’t to say that old zones (or support/resistance identified weeks or months ago) don’t work; they do.
Yet, recency is more necessary. To summarise this difference when looking at supply and demand vs support and resistance :
- Support and resistance relies on historical data. You will need to go back to your chart to pinpoint these areas before concluding they are support or resistance.
- With supply and demand, you don’t need to go back to the past to spot good zones (but nothing stops you).
Lines versus zones
Another primary difference is that we refer to supply and demand as zones, while we often look at support and resistance as exact levels.
Supply and demand offers roundabout areas where we anticipate a turning point. We don’t need to worry about the price reversing at an exact level compared to support and resistance.
Traders face several challenges with the latter. The first one is that the market doesn’t always stall at precise levels (but near it) before turning. Let’s look at an example with the chart below.
Note the resistance at 75.300 and support at 70.900 on CAD/CHF. However, see how the pair reversed several times close to these levels without touching them. These would have represented decent supply and demand zones.
Another problem is that the price can sometimes hit the exact level but quickly turn around. This is what we call a false break. However, you can use this occurrence to your advantage, and this is how you can combine support and resistance vs supply and demand.
It’s a common scenario, meaning it’s beneficial to understand. Here’s an example:
Notice how the price reversed from the supply zone. On the second occasion, it touched the 169.100 resistance, but this turned out to be a false break.
A simple way to identify a false break is with price action by looking at candles with long wicks or engulfing patterns (learn more about these here). We see a bearish Maribozu or full-bodied candle in this area.
One way to enter such a trade is to wait for the price to retrace to 50% (using Fibonacci) of the move. Eventually, this zone proved influential, resulting in a decline stronger than the previous.
Conclusion
So, support and resistance vs supply and demand: the former deals with pre-determined levels, while it’s not necessary to have pre-determined levels with the latter.
Also, support/resistance typically refers to exact levels, while supply and demand is more about zones.
Otherwise, these are two sides of the same coin; they are technically quite alike. Whether one person calls it support and resistance or supply and demand, the purpose is the same: to look for turning points.
Remember that this article scratches the surface. What we have provided are merely theories. Some traders go deeper into why price changes the way it does by looking for other evidence using indicators, fundamentals, order flow, etc.
