What better way to start the new year than with a post about mistakes.
Making mistakes is a part of trading, a part of life even. And there’s a whole bunch of them you can (and will) make trading supply and demand.
Many of these will be small things, like entering with the wrong signal or trading the wrong zone. These will cause the odd loss from time to time, but nothing too damaging. However, there are other, much bigger, mistakes that can do real damage to your account, and that must be avoided at all costs.
We’re going to look at the 3 biggest of these today.
I’m going show to you what they are, why traders make them, and give you some advice on how to avoid or mitigate them in your trading.
Let’s take a look.
Thinking Supply And Demand Is How The Whole Market Works
I’ve seen this one A LOT over the years, and it’s something I did myself when I first started trading S & D.
Supply and demand is a trading strategy, but more than that, it’s a theory on how the forex market works. The strategy tells us how and why things happen in the market, which we automatically accept as being true by using the strategy – we wouldn’t trade it if we didn’t think it works.
The theory is basically summed up as:
The theory makes a lot of sense, and obviously, we can see it works from the many reversals that take place from supply and demand zones on a daily basis.
However, many people make the mistake of applying this theory to the entire market.
In other words, once they start trading S & D, they assume everything that happens is in some way caused by a supply or demand zone.
They don’t think support & resistance levels, round numbers, or any other technical points are behind upswings and downswings, only supply and demand zones. And if they do see a reversal that isn’t from a zone, they pass it off as being from a zone on a different time-frame, not anything else.
Maybe you’ve done this yourself?
It’s understandable why traders think this, and as I said, I made the same mistake myself.
I thought S & D caused every move in the market. If I saw a reversal, I assumed it was from a zone even if one wasn’t present on that timeframe. In fact, I’d often go down in timeframe until I found a zone that lined up with the reversal, just to prove that a zone was behind it.
What I realized later on, however, is that this isn’t true, not in the slightest.
While supply and demand zones are behind most moves, they don’t cause everything. Other events also set off reversals. These usually form from supply and demand zones, making it seem as though the zone was behind it when in reality it was something else.
A great example of this are big round numbers.
At first glance, this reversal looks like it was caused by the supply zone. And most supply and demand traders would say the zone was behind the reversal because they naturally believe all moves are caused by zones.
But take a look again…
A big round number 1.25500 and a resistance level also fall in line with the zone.
These could have also caused price to reverse, and their respective traders would believe they are what caused the reversal, again because of what I said earlier.
So who’s right then?
What really caused this reversal?
Was it the supply zone, the resistance level, or the big round number.
Now the honest answer is I don’t know.
I don’t know which of these technical concepts caused the reversal. There’s no way to know for sure because none of them have any sort of statistical backing behind them; they’re simply theories created by traders who think they understand the market.
That being said, by understanding how and when each strategy works, we can figure out which one it is through the process of elimination.
So, let’s start with the supply zones.
In supply and demand trading, old zones don’t cause reversals because of the way the bank’s trade. Like I’ve explained before. So, if the supply zone in the image is old, we know it didn’t cause the reversal, it must have been the big round number or the resistance level.
And as it turns out, the zone is old.
It formed 35 days before price returned, which is considered old for the 1-hour time-frame – I’ll talk more about old zones later on.
So because it’s old, we can rule this supply zone out of being behind the reversal.
Next up is the resistance level.
Now to me, support and resistance levels aren’t a real concept in trading. By that I mean, I believe they exist, but only as short term levels like supply and demand zones.
I don’t buy into the idea levels with multiple past touches cause price to reverse, as it just doesn’t make any sense.
Why would the banks think it appropriate to buy from the same spot where price reversed 3 or 4 times in the past? What rational reason would they have for doing that? I’ve never been able to think of one, so to me, support and resistance levels only exist when they have recent touches.
As you can see, our resistance level doesn’t have that.
It has multiple touches as all levels should, but none are unbroken. They two most recent that were unbroken (blue arrows), got broken when price shot up before the reversal began.
It has multiple touches as all levels should, but they’re from a long time ago, none are recent. On top of that, the most recent touch was broken by a large decline at the end of last year, which invalidated the level as having any value or significance behind it.
So the reversal probably wasn’t caused by the resistance level either, which only leaves one more option…
The 1.25500 big round number.
Unlike the other two concepts, big round numbers do have statistical evidence backing them up.
Scientific papers have been written about their significance in multiple markets, and if you look at Oanda’s order book, you can clearly see orders build up around big round numbers all the time.
But why would price reverse at a big round number?
Well, because of how the banks trade, they have never have enough orders to buy or sell in one go. They have to split their trades up and place them when enough orders are available. They typically do this at similar prices, to replicate the effect of having their trades placed all in one go.
This will be familiar to those of you who have read my books.
To make this process easier, the banks always try to push price to points where they know a bunch of orders have built up. That way, they can use them to get more trades placed in one go, lessening the amount needed later on.
And where do lots of orders build up?
At big round numbers prices.
So the reason price reverses from big round numbers is because the banks use the orders that have built up to place trades, take profits or close trades. And the reason the reversal in our example was most likely caused by the BRN is that it’s the only level with sufficient evidence behind it.
Now, what am I suggesting with all this?
Do I think you should cross-examine every supply and demand zone to see whether it’s going to cause a reversal or if it’ll be something else?
No, that would be crazy, and pretty time consuming too.
All I’m saying is that don’t assume every event, reversal, or whatever happens as a result of your trading strategy.
Forex is a huge market, full of complicated variables that interact with one another in strange ways. To break it down to the point where only one theory (S & D in this case) is behind everything is a massive oversimplification that will only result in you losing money and not knowing why.
As Einstein once said, make things as simple as possible, but not simpler.
I know it’s not easy to figure out what’s caused a reversal, so before we move on, here’s a quick overview of what technical points cause reversals depending on where price is at.
1. Most short term reversals – reversals close to the recent price action – are caused by new supply and demand zones, as the banks always want to get their trades placed/profits taken quickly.
2. When a supply or demand is too old to cause a reversal, the next most likely candidate are big round numbers. Some short term reversals are caused by big round numbers too, but it’s impossible to determine whether it was them or a new S + D zone, so it’s better to just assume it was a zone.
Note: Big round numbers are best viewed as zones rather than levels, kind of like S & D. Check my VIP post to learn how to draw the zones properly and use them in your trading.
3. Support and resistance levels in their traditional form don’t exist. However, levels with at least two unbroken recent touches can and often will cause short term reversals.
You’ll usually see this when price moves sideways after a sharp move and creates two swing lows or highs at similar prices. After the second low or high forms, price will come back and reverse from a similar point. A weak demand zone sometimes forms from the second high/low too, but not always.
Drawing The Zones The Wrong Way
Drawing zones the right way is THE most important skill in supply and demand trading. If you don’t know how to draw the zones properly so that they encompass the right points, you won’t be able to enter trades correctly, and it’ll be extremely difficult for you to make consistent money.
In itself, drawing the zones correctly isn’t difficult:
You find the source of the move the supply or demand zone has formed on, then drag a rectangle from the beginning of the move to the most recent lowest or highest high; highest high for supply zones, lowest low for demand zones.
So why do so many traders get it wrong then?
Well, because they don’t get taught to draw zones correctly in the first place.
Over the past 10 years or so, supply and demand has gone from being a niche strategy only used by a few traders in forums to rivaling support and resistance trading. In fact, supply and demand today receives almost as many google searches as support and resistance trading…
It’s good that supply and demand has become more popular – the more the merrier after all. But one unfortunate side effect of this is it creates many guru’s who claim they know how to trade S & D but don’t really have a clue.
I’m sure you’ve come across some of these yourself.
These gurus teach traders their interpretation of how to trade supply and demand. The problem is because they don’t really know how to trade the zones, a lot of what they teach isn’t correct. With the perfect example of this being the way some gurus teach traders how to draw the zones.
Tell me, have you ever seen someone draw zones like this…
Looks pretty crazy, doesn’t it?
Believe it or not, this is how many guru’s teach traders to draw supply and demand zones.
According to them, this is the right way to draw the zones because the candle body is where the banks bought or sold, therefore it’s the point where price will reverse upon returning to the zone.
Now obviously, this isn’t correct.
The banks always place their trades at swing highs and lows, as that’s when the maximum amount of opposing orders are coming into the market. So drawing the zones this way, while it may net you the odd winner here and there, will consistently cause you to lose money and miss trades.
The right way to draw zones is from the open of the first small candle in the rise/decline that created the zone to the most recent highest high or lowest low; highest high for supply zones, lowest low for demand zones.
Here’s how that looks like with a demand zones.
And here’s how it looks for supply zones.
There’s a bit of a knack to drawing the zones correctly, but if you spend a couple days on it, it shouldn’t be too hard to pick up. My drawing supply and demand zones guide goes into much more detail, so check that out if you want learn more.
Trading Old Zones
And last, but not least, we have trading old zones.
Trading old zones is a mistake born out of misinformation.
When supply and demand was created many years ago now, the main guru was Sam Seiden. He created the strategy using his experience working at the Chicago Mercantile Exchange and translated it into a retail trading strategy.
Sam came up with many of the concepts now familiar to user trading S & D today.
Concepts like the idea the banks make price return to zones because they can’t get all their trades placed at a single price comes from him, as does the fact zones form at the source of large rises and declines as a result of the banks placing trades, which is a core component of S & D trading.
We have to thank Sam because without him we wouldn’t have S & D trading, and this site probably wouldn’t exist. But just because he created the strategy as we now know it, doesn’t mean he got everything right.
And nowhere is this more evident than his insistence old zones work just as well as new zones.
While Sam hasn’t said this himself – at least from what I understand – it is heavily implied through his teachings and how he often cites old zones as examples of successful trades.
It’s obvious why Sam thinks old zones cause reversals and why so many traders believe him. I mean, take one look at the charts, and you’ll see price reverse at old zones all the time.
The thing is, while price looks like it reverses because of these zones, in reality, it has nothing to do with it.
And here’s why…
Supply and demand zones form from the banks placing trades, and in some situations, taking profits. They place their trades, a zone forms, then they make price return later on. They make it return because they weren’t able to get all of their trades placed, due to a lack of orders entering the market.
So far, so supply and demand 101.
The important point that no-one seems to think about is why would the banks wait weeks, months, or even years in some cases, for price to return to a zone?
I mean, think about it…
If a bank bought some Eur/Usd, but didn’t get their entire order filled – so had to make price return to a demand zone – are they really going to wait 3 or 4 months just for price to return?
Of course not, right?
By that time, the whole economic situation may have changed. And your reasons for entering in the first place might not be valid anymore, making it riskier to buy again.
This is why old zones don’t cause reversals.
It doesn’t make sense for the banks to wait a long time to get their remaining trades placed. The longer they wait, the more that changes in the markets; the sentiment changes, the economic situation changes, and many other things change, all of which make it much riskier for them to buy or sell again.
So I guess the next question is:
How do you determine whether a zone is old or not?
Nobody knows for sure what constitutes to an old zone or not. Like I said, most guru’s see all zones as the same, so they don’t distinguish between them.
That being said, I do have some guidelines you can follow to determine if a zone is old or not:
1 min/5 min/15 min charts – 1 day.
30 min/1 hour/4 hour charts – 20 days.
Daily chart– 3 months.
Obviously, these won’t be accurate 100% of the time, so it’s a good idea to give it an extra couple of days/weeks for price to reverse – depending on the timeframe, of course.
Keep in mind too that if a zone forms inside a higher timeframe zone, like a 1-hour zone inside a daily zone, for example, the 1-hour zone falls under the same time as the daily. There’s no difference between them because the banks will use the 1-hour zone to place their daily trades.
The Bottom Line
It’s impossible to not make mistakes trading supply and demand.
It’s a fact of trading we all just have to live with. That being said, I hope with this guide, you now know which of the big ones to avoid when trading S & D, and can stay on the right track without suffering major losses.
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