The operation of the financial markets might at first glance appear daunting. However, what is operating behind most of the action in the market is an extremely ancient, simple law: supply and demand. Whether stocks, bonds, real estate, or commodities are in the market, the premise for the change in price is based on the supply-and-demand mechanism. If you ever wanted to learn why some stocks suddenly jump up or house prices quickly climb in a particular neighborhood, then this blog will walk you through the fundamentals with one controversial idea: supply and demand in the financial markets.
This blog is for those looking to learn one of the most basic economic concepts to invest in. We will define it in simple terms, illustrate how supply and demand affect prices, explain basic economic concepts in investing, describe market trends driven by demand, and beginner supply-demand analysis in order to navigate actual market trends.
Supply and demand in the financial markets is the match between the quantity of a financial instrument that people are willing to buy (demand) and the quantity available for sale (supply). The match has a direct impact on prices. Prices increase when demand exceeds supply. Prices generally drop when supply exceeds demand.
In the stock market, for instance, when there are more people who want to buy a stock than sell it, prices increase. When there are more who want to sell than buy, prices drop. The same applies to housing markets, commodities like oil and gold, cryptocurrencies, and practically any other asset that is tradable.
Using this basic idea allows investors to make intelligent investment choices. It also facilitates some of the other basic economics principles of investing, including market equilibrium, price behavior, and investor sentiment.
To observe how supply and demand drive prices, read the following examples, each of which demonstrates real financial market activity:
Where there are larger numbers of buyers looking to buy an asset and supply does not shift, buyers' competition causes the price to rise. This is often seen with trendy stocks following positive earnings or favorable news. Buyers' sudden surge in interest creates upward pressure on prices, revealing demand-driven market trends.
If there are fewer buyers of an asset but more sellers, then prices decline. One might say this is mostly observed when investors panic sell on negative news and cause a glut in the market with supply, thereby pushing prices down. Here, the impact of supply and demand on prices is clear as day—more sellers than buyers puts downward pressure.
Since the number of buyers at a given price is the same as that of sellers, the market is in equilibrium. Prices here will tend to stay stable, an indicator of a neutral state of mind. Although less dramatic, this equilibrium acts to keep the markets healthy.
These are just a few examples of the direct influence of demand and supply in financial markets and the reason why investors need to be acutely sensitive to this phenomenon.
Investor demand drives and sustains most market trends. From technology to clean tech to healthcare, demand-driven market trends are where investment opportunity and long-term return come from.
For example, between the late 2010s and the early 2020s, the electric vehicle and renewable energy sectors saw high valuations. It was not purely all company performance. It was mostly caused by belief in the long-term future of the sectors that generated extra demand for the stocks and ETFs related to them. Prices went up on the expectations basis alone even prior to profitability being achieved—a classic example of demand-driven market momentum propelling asset prices.
In this way, even a novice supply-demand analysis could be valuable information for decision-making.
Supply and demand in financial markets are more comprehensible if you look at real-world applications:
In early 2020, world travel was brought to a standstill by the pandemic. Oil demand went into a tailspin. But producing countries went ahead and produced for a while, creating a massive oversupply. Prices plummeted as storage tanks overflowed. Oil futures even became negative for a short period of time.
This event squarely illustrated the power of supply and demand to drive prices. The sudden absence of demand, coupled with inflexible supply, generated a record market outcome.
Early in 2021, shares in GameStop suddenly exploded. Retail traders, monitoring social media boards, began buying shares in a heavily shorted stock. As demand very quickly escalated and supply was low, the price exploded, forcing short sellers to cover shorts—raising demand once again. It was a classic case of demand-driven market action on the basis of social opinion, rather than traditional financial metrics.
These examples show that, besides textbook definitions too, supply and demand in financial markets are key to why and how prices move.
You do not require technical software or special equipment to execute a beginner supply-demand analysis. The following is an easy process you can use:
Choose a stock, commodity, or other instrument you want to analyze. Choose something you know or want to watch every day.
Take a look at price charts over several different time frames (dailies, weeklies, monthlies). Are the prices going up, down, or sideways? Such price action is generally initial indication of changing supply or demand.
Volume is the amount of trades made during a time frame. Increasing volume with increasing prices will generally signify increasing demand. Decreasing volume could signify decreasing interest or a reversal in progress.
Financial news, earnings releases, new product introductions, and foreign events can alter supply and demand with one overnight shift. Tracking investor sentiment—bull or bear—can provide some indication of direction in demand.
For commodities, watch for inventory reports. For real estate, look at starts. For stocks, look for share dilution or stock repurchase programs. All of these signal a shift in supply.
With these five steps, beginner investors can begin using beginner supply-demand analysis to form educated opinions on where a market might be headed.
In investing, knowledge is power—and information on supply and demand in financial markets provides a realistic framework to understand price action. It enables investors to:
As one of the easiest economic concepts to apply to investing, supply and demand enable you to decode market messages and avoid costly mistakes. Successful investors are not necessarily crafty equation writers, most would suggest, but rather a good grasp of basics—among the most important of which are supply and demand's rules of thumb.
In business, trends fall away, news cycles turn over, and technology advances. But one thing never changes: the power of demand and supply to move markets. Whether individual stocks or broad market averages, buyers' and sellers' balance always set price.
By understanding how demand and supply influence prices, even new investors can forget guessing and start making more intelligent choices. Paired with observation of the real world and monitoring statistics, even a novice supply-demand analysis is a powerful decision-making tool.
As you move forward in studying investing, keep this principle in mind often. Not only is it something out of your high school economics book—it's the foundation for every price you'll ever see on the financial ticker. Keeping this simple concept in mind will have you well on your way to creating better strategies, recognizing demand-based market trends, and moving through the dynamic world of investing with ease.
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