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Published On: Fri, Nov 16th, 2012

Supply and Demand and the Effect on Price Activity

by Richard Cox

In order to successfully trade in the spread betting markets, traders must be able to have a strong understanding of where specific asset prices are likely to head in the future.  So here we will strong down market behavior to its essential elements in order to understand how price activity moves over time and how these prices are influenced by market participants.

The most important of these elements can be found in asset supply and asset demand, as buyers and sellers in an individual market push against one another in a general effort to reach an equilibrium point (which would be the appropriate, or fair market value) for an asset.  But since this equilibrium point is never actually reached (as market conditions are always changing). It is because of these constant changes that spread betters are able to profit from these markets.

Defining Supply and Demand as Market Elements

When dealing with the spread betting markets, Supply is essentially the quantity of asset that is currently available to be purchased in the current market environment.  Conversely, Demand, refers the willingness of the general market to buy an asset at its current price.  When demand is strong, many people are interested in buying the asset and, as a result the price of that asset increases (as there is less and less of that asset available).   If demand is weak, prices tend to drop as the market sellers look to find a price new buyers are willing to pay for the asset.

On the other side, when supply is high, prices tend to drop, as sellers need to find buyers in order to reduce that excess supply.  But when supply is low, there are too many buyers chasing too few goods, and as a result prices will rise in order to meet the external market demand.  These are the essential elements in understanding market prices for spread betting assets are rising or falling at any given moment.

Reasons for Price Volatility

In some cases, however, prices will not change in an orderly or stable fashion.  These times (described as instances of high price volatility) will often come when market conditions are changing and investors are reassessing their opinions on what the true value of an asset should be.  An example of this might be seen after a major economic release, as analysts look to understand the implications for the market and the true price levels that should be available for traders.

During times of high volatility, upward moves in price suggest that investor demand is strong and that asset supply is limited.  When these conditions are seen, the price of an asset will rise.  Conversely, when downward moves are seen, this is a suggestion that supply is large and demand is weak.  When these conditions are seen prices for an asset will see declines.

Determining Market Sentiment and Trading Direction

Given all of these factors, the ideas of supply and demand that are present in the market can prove highly valuable when traders are looking to place trades.   The upward or downward movements in price will give traders an idea of the broader market sentiment that is actually in place.

When an asset is gaining in value (small supply, strong demand), market  sentiment is bullish and the underlying momentum for the asset is positive.  Assets declining in value show that market sentiment is bearish and that the underlying momentum for the asset is negative.  This is important for traders because prices are likely to continue in this momentum direction until there is another significant market event that changes the overall sentiment for the asset, and, by extension, the eventual price movements for that asset.

Conclusion

When traders are looking to understand the critical forces of price movements in the market, supply and demand represent the most substantial reasons for why prices rise or fall at a given time. Understanding these forces can help traders to determine the underlying market sentiment and momentum, and this can be critical when entering into new positions.

 

 

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.

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