Identifying supply and demand
Day 11 of 26 · 10 min read · By DT Terminal
A supply or demand zone is an area price left quickly, which suggests unfilled orders were waiting there. This lesson shows how traders commonly find these zones, how they are usually drawn, and what tends to make one more or less useful when price comes back to it.
Unlock the full lesson in the app
Worked examples, the quiz and the interactive tools are in the app. Free account.
What supply and demand zones are
Sometimes price pauses in a tight area, then leaves it fast. A demand zone is one price rallied away from: buyers outweighed sellers. A supply zone is one price dropped away from: sellers outweighed buyers. A move that fast may leave orders unfilled, which can slow or turn price when it comes back.
- The leg in brings price to the area.
- The base is the few small candles where it paused; the zone is drawn from these.
- The departure is the move away. Its speed and size matter most.
Go deeper
Price moves when the orders on one side outweigh the other. Most of the time buyers and sellers roughly balance and price drifts. Treat a zone as a place to watch and to test in your backtests, not a place price has to turn.
This lesson reads candles the way How to read candlesticks taught, and uses trends and breaks of structure from Market structure.
The four formations
A zone is named after the leg in, the base and the leg out. The leg out decides the zone: a rally away leaves demand, a drop away leaves supply. The leg in decides the family: the same direction both sides is a continuation, opposite directions a reversal.
| Formation | Leg in | Leg out | Zone | Type |
|---|---|---|---|---|
| Rally-base-rally | Rally | Rally | Demand | Continuation |
| Drop-base-rally | Drop | Rally | Demand | Reversal |
| Drop-base-drop | Drop | Drop | Supply | Continuation |
| Rally-base-drop | Rally | Drop | Supply | Reversal |
A base is one to a few candles with small bodies compared with the candles either side.
Go deeper
What counts as a base is a judgement, but the common picture is the same: small bodies, often smaller than half of their own range. A base that runs for many candles is closer to a range than a zone, and many traders skip it.
Drawing a zone from the base
A zone is two horizontal lines drawn from the base and extended right until price comes back.
- The proximal line is the edge price reaches first on the way back: the top of the base for demand, the bottom for supply.
- The distal line is the far edge: the lowest wick in the base for demand, the highest wick for supply. A close beyond it is the usual sign the zone has failed.
Set the proximal line on the base's bodies for a tighter zone, or its wicks for a wider one. Pick one and draw every zone the same way.
Interactive tool
Zone drawer
This interactive tool runs in the app, with your own numbers.
DT Terminal ChartsEURUSD · H1Demand zoneThis chart in numbers, and drawing it in the backtester
Neither way of setting the proximal line is correct, but mixing them means the results of your backtests will not mean anything. Switch between them in the zone drawer.
The chart is an illustrative EURUSD H1 drop-base-rally. Drawn on the bodies, the proximal line sits at 1.08413 and the distal line at 1.08297, a zone 11.6 pips tall. The rally left it at 88.9 pips, about 7.7 times its height. When price came back, the first test traded down to 1.08319, 9.4 pips inside the proximal line and 2.2 pips above the distal line, and no candle closed below the zone.
In the backtester you can draw the same thing with the Rectangle tool, from the first base candle to the right edge of the chart, or with two Horizontal lines on the proximal and distal prices. Drawing it the moment the departure finishes, before you play on, is what keeps the practice honest.
Measuring a zone: height and departure
Two numbers describe a zone before price returns: its height, proximal minus distal, and its departure, how far price left it. Departure divided by height is the departure multiple.
Worked example
Example 01: A drop-base-rally demand zone on EURUSD H1
The worked example, with every number walked through, is in the app.
The wick version, and the first test
Price dropped three candles from 1.0921 into the base, then rallied three candles. Drawn on the wicks instead, the proximal line moves up to 1.0866 and the zone is 19 pips tall.
Four candles after the rally peaked, price came back. The first candle into the zone traded down to 1.0857, 5 pips inside the proximal line and 10 pips above the distal line, and closed back above the zone. Over the next two candles price rose to 1.0909, 52 pips off the test low.
What makes a zone stronger
Traders grade zones on things visible before price comes back.
- A fast, large departure. Few long candles, little overlap, several times the zone's height. Example 01 left at 3.7 times.
- Little time at the base. One to a few candles. The usual reasoning: the longer price sits there, the more waiting orders it has already filled.
- Fresh. Price has not been back since the departure. On the same reasoning, it still has whatever orders were left.
| Factor | Usually stronger | Usually weaker |
|---|---|---|
| Departure | Fast and large: a few long candles, several times the zone’s height | Slow, overlapping candles that drift away |
| Time at the base | One to a few candles | A long, wide base |
| Tests | Fresh: price has not been back | Tested once or more |
| Higher timeframe | Demand in an uptrend, supply in a downtrend | Against the higher-timeframe trend |
Supply and demand
Four formations, strong to broken
- Demand zone
- Supply zone
- Fair value gap
Rally-base-rally
continuation
Drop-base-rally
reversal
Rally-base-drop
reversal
Drop-base-drop
continuation
Fast and fresh
few long candles out, not tested yet
Slow departure
overlapping candles drift away
Tested once
price came back and turned
Broken
a close beyond the distal line
Go deeper
A departure that leaves a gap between candles often leaves a fair value gap too, which Identifying fair value gaps covers.
Zones and the higher timeframe
A demand zone at a higher low in an uptrend, or supply at a lower high in a downtrend, sits with the bigger trend. Traders watch most closely the zones whose departure broke structure.
Worked example
Example 02: A demand zone against the higher-timeframe trend
The worked example, with every number walked through, is in the app.
Go deeper
The diagrams use the same trends as the Market structure lesson. In each, the move out of the zone broke the last swing (a break of structure), so the base it left sits with the trend. When the higher and lower timeframes disagree, many traders give the larger structure more weight.
In the example, the H4 downtrend made a lower high at 1.2795 and a lower low at 1.2650, and the M15 zone was a drop-base-rally. When price came back, the first test reached 1.2716 and bounced only 14 pips to 1.2730, about 30% of the departure. The next drop closed at 1.2702, 8 pips below the distal line, and the zone was gone.
Rules for the rulebook might be: a fresh zone only, a base of one to three candles, a departure of at least the multiple you choose, and the higher timeframe trending your way.
Turn the checklist into a rulebook
What weakens a zone
Each return to a zone is thought to use up some of the orders left there. The first test meets the most; by the third, little may be left.
- A test is one visit to the proximal line, however long it stays.
- A break is a close beyond the distal line; a wick through that closes back inside is a test.
- A smaller bounce each time warns that the zone is weakening.
Worked example
Example 03: A supply zone on XAUUSD that holds once and breaks on the second test
The worked example, with every number walked through, is in the app.
Test your zone rules in the backtester
EURUSD on H1. Mark each zone as its departure ends and record what price does at tests one and two.Go deeper
That is why many traders give a zone the most weight on its first test and treat it as spent after one or two. In the backtester, note each zone's height, its departure multiple, whether it is fresh and which way H4 is trending, before you see what comes next.
In the example, price rallied into a two candle base and dropped away. The first test pushed $2.60 into the zone and turned, and price fell $18.50. On the second visit there was no turn: two candles in, the second closed at 3,346.70, above the distal line at 3,343.90.
A broken zone is not always finished with. Traders often watch a broken supply zone as possible demand when price returns to it from above, and the reverse for broken demand. Treat that the same way as any zone: something to test, not a certainty.
Check yourself
Quick review · 0 of 0
Quiz
Check yourself: 1 question
Answer each question and see why it is right, in the app.