Why are stock prices volatile? What does the supply rule mean?

If you’ve ever wondered why stock prices sometimes hit the ceiling on certain days and plummet to the floor on others, the answer lies in a simple concept: Supply refers to the willingness to sell, and Demand refers to the desire to buy. When demand exceeds supply, prices rise; when supply exceeds demand, prices fall. However, this is not as straightforward as it seems because many complex factors influence changes in supply and demand.

If you are an investor looking to systematically time your buy and sell decisions, understanding supply and demand is not just general knowledge but a crucial tool that helps you read the market sentiment accurately. This article will guide you to deeply understand this fundamental concept and learn how to apply it in real stock trading.

What does supply mean? And does demand have a different meaning?

Demand in economics refers to the quantity of goods or services that buyers are willing to purchase at various price levels. Contrary to the common misconception that demand simply means “wanting to have,” demand actually involves the relationship between price and the actual quantity exchanged.

Think of it this way: if an apple costs 10 baht, you might buy 5 pieces. But if the price drops to 3 baht, you’re willing to buy 20 pieces. This relationship is what economists call the “law of demand,” which significantly influences consumer decision-making, including the effects of the Income Effect(Income Effect), where a price decrease makes your money more valuable, and the Substitution Effect(Substitution Effect), where you might switch to cheaper alternatives.

Supply, on the other hand, refers to the quantity of goods that sellers are willing to offer at different prices. For sellers, a lower price signals lower profit margins, so they are less inclined to produce more. When prices rise, profits increase, encouraging producers to increase supply. This is the “law of supply,” which is the opposite of demand.

Price equilibrium: the intersection point of buying and selling

The prices we see in the real market are not determined solely by demand or supply alone but by their intersection, called Equilibrium(Equilibrium). It is the point where the quantity of goods buyers want matches the quantity sellers are willing to supply.

Imagine a stock market in the afternoon: when good news arrives, buyers want to push prices higher to buy shares, but sellers hesitate to sell, believing prices will go even higher. This creates excess demand, pushing prices up until they reach a level where sellers are willing to part with their shares, establishing a new balance point.

Conversely, when bad news hits, buyers become hesitant, and sellers rush to sell, creating excess supply and downward pressure on prices. The price then adjusts downward until buyers regain interest at the lower levels.

Factors driving demand and supply in the financial markets

In real stock markets, demand is influenced not just by price but also by many other factors, such as liquidity of the financial system. When central banks release more money, investors have more cash and want to buy assets to hold, increasing demand.

Investor confidence is equally important. When people believe the economy will grow and companies will be profitable, they are willing to buy stocks at higher prices. If confidence wanes, demand shrinks.

Supply factors include not only price levels but also corporate policies, such as issuing new shares (which increases supply), share buybacks (which reduce supply), IPOs of new companies (adding to supply), and regulations that restrict insider sales.

How to read demand and supply from candlestick charts

Technical traders often use Price Action and candlestick patterns to interpret buying and selling pressure. A green candlestick with a long body indicates strong buying pressure, with buyers pushing prices higher. Conversely, a red candlestick with a long body signals strong selling pressure.

Doji candles(Doji), where open and close prices are nearly the same, show indecision between buyers and sellers, often indicating a lack of clear direction despite new factors.

Continuous uptrend expansion: the era of re-accumulation

When a stock begins to rally(Rally) and reaches a high point, sellers start to emerge, causing a short-term consolidation(Base). When good news arrives again, buying interest intensifies, sellers give up, and the price breaks through the previous resistance, continuing upward(Rally again). This pattern, Rally-Base-Rally(RBR), is considered one of the best demand trading patterns.

Traders who understand this pattern can buy at breakout points, set stop-losses below the consolidation, and wait for profits, as the trend is still strong and buying momentum continues.

Reversal of a downtrend: when selling pressure wins

Conversely, when prices reach a certain rally point(Rally) and then consolidate(Base), but bad news arrives, buyers hesitate, and selling pressure increases. Prices break below the support of the consolidation and fall further(Drop). This pattern is Rally-Base-Drop(RBD).

In this scenario, traders should reduce their positions because the trend has shifted, and expect further declines to various support levels.

Major reversal patterns: when equilibrium shifts back

Besides continuous trends, there are opposite situations where stocks decline with heavy selling(Drop), reaching a point where buyers see value and start accumulating, causing a pause(Base). When good news comes, buying surges, breaking through the previous resistance(Rally), indicating a potential trend reversal. This pattern, Drop-Base-Rally(DBR), is considered a high-probability reversal signal.

Summary and practical application

Supply means willingness to sell, and demand means willingness to buy. This phenomenon is not just a classroom economic theory but a fundamental mechanism controlling the movement of stocks and all assets. Those who can read and predict changes in supply and demand can more accurately time their buy and sell decisions.

However, these theories require real-world testing. It’s not enough to read about them; observing candlestick patterns and understanding various formations is essential to become accustomed to making decisions. Ultimately, remember that no method guarantees 100% success; proper risk management is crucial.