Intro to Supply and Demand Zone Technical Analysis

Supply and demand is an increasingly common strategy among day and swing traders in equity, forex, and the futures markets. The goal of analyzing supply and demand zones is to pre-determine where price action may pivot before that pivot happens, thus giving us an edge over the market.

There are many unique charting/trading strategies that fit under the supply and demand umbrella, however we are going to focus primarily on Institutional Zones of Supply and Demand Imbalances, as this is what our TradingView indicator actively displays.

What are Institutional Zones of Supply and Demand Imbalances?

First, let’s break down the phrase above. The first word is ‘institutional’, which is a key aspect in our trading. As a retail trader, you must understand that retail traders (individual traders like you and I) have very little control and very little effect on price action in the major markets. The price action that we see everyday is caused by large institutions and hedge funds buying and selling equities in massive quantities.

This chart displays the price action for ES, which is the S&P500 E-mini futures.

At the time this guide was created, that chart for ES displays the low of this year (2022). You can see major highs and major lows, as well as steep drops and momentous runs.

Price action like this appears random to the naked eye, however it is all controlled by major institutions. These institutions place large buy and sell orders for markets such as the S&P 500 Index which causes these moves.

Our Institutional Supply and Demand Analysis attempts to discover the price zones where institutions have placed their buy/sell orders.  Their buy orders create “demand zones”.  And their sell orders create “supply zones”. Knowing where these zones exist allows us to anticipate price trend reversals so we can profitably participate in them alongside the major institutions when these key moves take place.

We are looking for areas in the chart where institutions have created major imbalances (more buy orders than sell orders or vice versa) which creates demand and supply zones that impact price action and trend reversals in predictable ways.

What Causes These Supply and Demand Zones?

Understanding that institutions control the price of the markets is crucial for understanding how these zones of supply and demand imbalances are formed, and it can be derived from historical price action.

There are two types of price action, balanced and imbalanced. Balanced price action is flat, consolidatory price action where the overall direction is sideways. Imbalanced price action is an exaggerated move in price either up or down.

Now here is the key: institutional supply and demand imbalances are formed when price action goes from balanced to imbalanced. Below is an example of balanced price action.

There are clearly areas of institutional buy and sell orders that are causing price action to oscillate between the areas of demand and supply. The longer price action consolidates and moves sideways, the larger the volume profile will be in this range. In other words, more institutional orders will build up as price remains relatively the same for a longer period of time.

Here is how a demand zone is formed:

Due to bullish CPI news, price action went from balanced to imbalanced by exploding to the upside. This bullish price action filled all of the sell orders and broke past the previous area of supply.  Because price moved up so fast, the buy orders did not get a chance to fill, essentially leaving an area with a high concentration of buy orders remaining.

Hence, a new demand zone is formed which is shown above.

Our state-of-the-art indicator automatically scans for these historical shifts in price action (balanced to imbalanced) via our supply and demand zone detection formula, and displays them on your chart instantly. Remember the first image sent of blank price action? Here it is below:

The image below shows the exact same chart of ES, however, our advanced Professional Zones – Institutional Supply and Demand Imbalances indicator has been applied to the chart.

Just like that, price action has been transformed from unexplainable chaos to an orderly sequence of demand bounces and supply rejections.

Yes, all of these zones may be charted manually if one were to acquire the knowledge required to chart them by hand, and spend numerous hours going back in time to find all these zones.  Additionally, these charts would then have to be constantly monitored and updated, which would require hours of work each day.  This powerful indicator automates all of that work to give you more precious time to analyze and trade these zone-driven pivots in the markets.

How To Measure the Strength of Supply and Demand Zones?

The longer the consolidation takes place, the larger the demand/supply zone will be. This strength is measured by the time frame of the origin of the zone.

Each zone may be formed on a different time frame, the biggest being the 1 Month time frame, and the smallest being the 30 Minute. Each supply and demand zone is automatically labeled based on the time frame from which the zone originated.

The weakest zones are derived from the 30 minute time frame. This means the zone only took two 30 minute candles to form, which is not a lot of time for institutions to place large orders. This means that the bounces and rejections off of these zones will usually be smaller, and usually won’t last more than a few days.

Larger zones such as 1 Day, 1 Week, and 1 Month often cause large swings in the market lasting weeks, months and even years. So pay attention not just to where the demand and supply zones currently appear, but also to the strength of that zone. You can see below that the demand zone that the market bottomed in and reversed out of in 2022 was in fact, a very strong weekly zone.

What is the Significance of Supply and Demand Zone Breaks?

These zones are order-based. This means that a supply zone level doesn’t turn into demand when price action breaks above it, and demand doesn’t turn into supply when price action breaks below it. It is unlike standard trend-based support and resistance levels. If price action breaks below demand by even $0.01, all of the buy orders have been filled and the demand must be deleted from the chart (and vice versa for a supply zone).

While it is possible to play these zone breaks as continuation plays off of current momentous price action, it is unpredictable how far price will go up or down after breaking supply or demand during that leg.

However, in my years of supply and demand experience, I have noticed that if demand breaks, the market will eventually come down to the next viable demand zone. This is because without a pivot caused by an institutional-created demand or supply imbalance, there is often not enough participation to cause a sustainable trend reversal for a long period of time. Below is an example of this:

Above is the 4 Hour chart of TSLA bouncing up off of a demand zone. We call this a bounce in “no man’s land”, as there is no major demand bounce to support this reversal to the upside. So in theory, price action should return lower to the next major historical zone of demand before it has a chance of pulling off a solid reversal. Here is what happened:

As you can see above, TSLA did indeed end up heading back down into the next major demand zone before getting a sustainable reversal to the upside.

So you may play these supply and demand zone breaks as continuation trades, either long or short, with a price target at the next major zone. Just make sure to use proper risk management and position sizing, as timing the trigger of a price target can be difficult. 

How Might I Place a Trade Using the Indicator?

Now that the basics of institutional supply and demand zones have been discussed, there will come a time that this strategy must be actively applied to personal trading with a goal of becoming profitable. Here is a step-by-step process to place a trade using supply and demand paired with an example of a day trade from the 1 minute time frame.

Step 1: Find a highly institutionally traded stock that is currently in supply or demand as shown by our indicator. For example, AAPL:

Step 2: Look for an above-average (exaggerated) volume spike. Because we are in one of the green zones at the bottom of the chart, we know that we are in demand where large institutional buy orders reside. We need to wait for some of these orders to actually fill before we take our trade. This is known as volume confirmation. The color of the volume usually does not matter in this situation.

Step 3: Now that we have a volume spike which is confirmation of large orders being filled, we need more confirmation that the institutional orders are not only a buy, but large enough to actually reverse the current trend.

This is ultimately a judgment call. A few green candles may be good enough to dictate a reversal, or a trend break. It comes down to personal preference and how aggressive you would like to be. Keep in mind, the longer you wait, the more confirmation your trade has, but also, the longer you wait, the greater the risk of missing the new trend.

In this example, we will use a trend line to confirm our trend reversal.

Step 4: Enter the trade. Now that you have proper demand confirmation, you may place your trade. Be sure to determine your stop loss, price target, position size, and all other risk management factors along the way.

In this example, AAPL ran all the way up to supply before rejecting; making for a perfect demand to supply call trade. Also, more short trade entries could have been taken based off of the multiple supply rejections AAPL had.

The Bottom Line

There are many ways one may go about trading the stock market. However in my years of trading and teaching, there has never been a strategy that has not only changed my career, but improved the trading careers of my students, more dramatically than Institutional Zones of Supply and Demand Imbalances.

Though charting new zones and deleting broken ones everyday was time consuming and repetitive, the results of trading these zones made it well-worth the hours of charting. However, after months of development and fine-tuning, the painful charting process has been automated by this powerful indicator, completely replacing the tedious charting work for myself and my students.

While numerous other indicators include the name “Supply and Demand Zones”, there is no supply and demand indicator remotely this advanced and accurate available on TradingView. Aurora Trading is blessed to finally bring this revolutionary tool to the market.