Posted 10th July 2024

Supply and Demand Trading Strategies for Precious Metals

Supply and demand trading strategies are a method of investing in the precious metals market. I’ll discuss how supply and demand trading works, how to identify the zones on graphs and how investors can use these indicators to make lower-risk, potentially highly profitable trading decisions.

Definition of Supply and Demand Trading

Supply and demand trading involves analyzing price charts to identify zones where supply and demand imbalances occur. These zones represent areas where a significant number of buyers or sellers are likely to enter the market, causing the price to move in a particular direction. The goal of traders using this strategy is to buy at demand zones (where prices are expected to rise due to increased buying interest) and sell at supply zones (where prices are expected to fall due to increased selling interest).

How To Use A Supply and Demand Trading

Identifying Supply and Demand Zones – Look for areas on the price chart where the price has previously moved sharply away, indicating strong buying or selling activity. These areas are marked as potential supply (resistance) or demand (support) zones.

Waiting for Price to Return to These Zones – Once a supply or demand zone is identified, traders wait for the price to return to this level. The expectation is that the price will react similarly to how it did in the past.

Entering Trades – When the price reaches a supply or demand zone, traders enter a trade in the direction of the expected move. For example, if the price reaches a demand zone, a trader might buy, anticipating that the price will rise.

Setting Stop Losses and Targets – To manage risk, traders set stop-loss orders to limit potential losses if the price moves against their position. They also set profit targets to lock in gains when the price reaches a predetermined level.

Identifying Supply and Demand Zones on Graphs

Identifying supply and demand zones on price charts involves looking for areas where the price has made a significant move up or down, often after a period of consolidation or ranging. These areas are characterized by large candlesticks or a series of candlesticks moving in the same direction, indicating strong buying or selling pressure.

The chart below is a one-year daily of the gold price  as represented by Comex gold futures contracts, with contract volume and the 50 dma (blue moving average line) and the 200 dma (red moving average line):

Look for Price Reversals and Confirm with Volume

Identify points on the chart where the price has reversed direction sharply. Check the trading volume during the reversal. High volume at the reversal point indicates strong buying or selling interest, reinforcing the validity of the supply or demand zone.

The sell-off during February 2023 dipped below the 50 dma briefly but the sell-off was not confirmed by volume and the gold price shot back up in early March. However, the price reversal in early May 2023 was accompanied by a surge in sell volume, which pushed the price below the 50 dma and eventually below the 200 dma. 

A high supply of gold contracts from sellers relative to buy demand from gold contract buyers ultimately pushed the price to a capitulative sell-off by early October 2023. Setting a stop-loss at the 50 dma would have prevented incurring a big loss from a long position during the supply zone period. 

In the context of applying Supply and Demand trading strategies, I likely would not have considered buying contracts until the price moved back over the 50 dma, which it did in late October 2023. However, the lower-risk, true Demand “pivot” did not occur until early March 2024, when the gold price launched off of and up from the 50 dma, accompanied by surge in buy volume.  In fact, the lower-risk strategy would have provided a $375 gain in the gold price. Moreover, using a trailing stop-loss on a long position would further reduce the risk of getting long gold. 

One more point. Using daily weekly time frames will lead to more successful application of supply and demand trading because longer time frames produce a more powerful trading signal than that of shorter time frames (hourly or minutes). 

Using The Supply and Demand Indicators for Precious Metals Trading Decisions

Investors can use supply and demand zones to make informed trading decisions by entering and exiting trades based on the price’s interaction with these zones. Here are some strategies for using supply and demand indicators:

Entry and Exit Points – Traders can enter buy orders at demand zones and sell orders at supply zones. This approach capitalizes on the expected price movement when these zones are reached.

Trend Confirmation – Supply and demand zones can be used to confirm trends. If the price consistently respects demand zones during an uptrend and supply zones during a downtrend, it reinforces the trend’s strength.

Risk Management – By setting stop-loss orders just beyond supply and demand zones, traders can limit their potential losses. This strategy ensures that if the price moves beyond the zone, the trade is exited, minimizing losses.

Combining with Other Indicators: Supply and demand trading can be enhanced by combining it with other technical indicators such as moving averages, RSI (Relative Strength Index), and MACD (Moving Average Convergence Divergence). This combination can provide additional confirmation for trade entries and exits.

Supply and demand trading is a powerful strategy that leverages the fundamental principles of market economics to make informed trading decisions. By identifying and analyzing supply and demand zones on price charts, traders can predict potential price movements and capitalize on these opportunities. This approach requires patience, discipline, and a keen eye for market patterns, but when applied correctly, it can significantly enhance trading performance and profitability and at the same time reduce risk.

Dave Kranzler is a hedge fund manager, precious metals analyst and author. After years of trading expertise build-up on Wall Street, Dave now co-manages a Denver-based, precious metals and mining stock investment fund.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The opinions expressed in this article, do not purport to reflect the official policy or position of Kinesis.

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