Supply and Demand in the Forex Markets

[RichardCox 10]

Forex markets are governed by the primitive forces of supply and demand, as alternate sides of the market buy and sell currencies and prices attempt to reach an equilibrium point (which is the most efficient market price, showing agreement between buyers and sellers). While this point is never actually seen with any element of finality, traders tend to look for reasons to explain why certain price movements happen rather than viewing these movements more broadly and in simpler terms. In its most basic sense, however, supply and demand is ultimately what dictates whether prices will rise or fall over a given period – positive sentiment tends to be created by supportive news, which leads to increases in demand and decreases in supply while negative sentiment leads to the reverse.

 

Supply and Demand Defined

 

Supply in the forex markets, it should be understood, is simply the quantity of currency that is available for purchase at any given time. Demand, on the other hand, refers to the interest the broader market shows in purchasing that currency. As supply of the currency increases, the price of that currency tends to fall, as it becomes much easier to obtain. Conversely, as market interest in that currency increases, prices tend to rise, as it becomes more difficult to find willing sellers and obtain that currency. This can be seen in the chart graphic below:

 

 

Theoretically, prices attempt to find an equilibrium point (seen in the center of the chart) but this is never actually reached in the forex markets, as the market is essentially a living organism that is constantly moving and changing (and trading is slightly inefficient ways). As we can see, when prices become cheaper, interest increases (as traders look for bargin rates). But when prices increase, this demand begins to disappear.

 

Influencing Price in Forex Markets

 

In essence, supply and demand push against each other in the forex marketplace to determine the price that will be paid for a given currency and the number of monetary units that will be seen changing ownership over a given time period. Free markets determine prices in this fashion and while there are some inefficiencies that exist (and limit purely free exchange) this is the over-riding driver that determines bullish and bearish movements in the markets.

 

Since the forex market is the most liquid and voluminous market in the world should not be surprising that these forces apply. Examples of events that can improve sentiment with respect to a certain currency can be seen if prices break a major psychological levels (creating a support or resistance breakout) or a fundamental event such as a central bank raising interest rates. In both cases, traders tend to see increased incentives to purchase the currency in question. As a result, available supply deacreases and prices move higher.

 

Signs of Markets Attemtping to Find Equilibrium

 

But even when these major events are seen (whether technical or fundamental in nature), there is only so far prices can travel before market participants become discouraged with the prospects of a trend and interest begins to dissipate. In these cases, it is a signal to traders that markets forces are attempting to reach the equilibrium point and the trend (positive or negative) is in danger of reversing, if not ready for an all-out reversal.

 

When traders zoom in to shorter term time frames, and secondary trends become apparent, traders are able to identify these market forces at work and to adjust position biases accordingly. Failing to identify these market forces as they become visible can lead to late trade exits and lesser gains in previously profitable positions.