Understanding the reason why a currency pair moves is essential to the development of every forex trader. At the most basic level, price moves due to supply and demand imbalances in the market at any given time. Perhaps one of the most important aspects of forex trading is understanding supply and demand. While certain topics in the world of forex may be optional depending on your style of trading, your ability to properly identify areas of increased supply and demand is paramount to your trading success.
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, therefore, is a reflection of supply and demand.
The demand for currencies is derived from the demand for a country’s exports, and from speculators looking to make a profit on changes in currency values. The supply of a currency is determined by the domestic demand for imports from abroad. For example, when the US imports cars from Japan it must pay in Yens, and to buy Yens it must sell (supply) Dollars. The more it imports the greater the supply of Dollars onto the foreign exchange market. A large proportion of short-term trade in currencies is by dealers who work for financial institutions.
The supply and demand of a currency pair are determined by the players in the forex market. These are governments, banks, investors, funds, and speculators. Thru their actions in the market, the participants in the forex market are constantly shifting the supply and demand of currency pairs, causing the price to fluctuate. If you open a currency trade you are taking part in the supply and demand equation within that market.
Knowing how forex supply and demand play a role in the market is extremely important to your trading success. It starts with understanding the concepts but the real value is knowing how to identify areas of value so you can begin capitalizing on them. To trade supply and demand methodology in forex you should: buy when the price bounces upwards from a demand area and place a stop loss below the zone, sell when the price bounces downwards from a supply area and place a stop above the zone. Hold your trade at least until the price action reaches an opposite level on the chart or use price action rules to manage the trade.