June 30th, 2021

Supply & Demand Levels Drive Price Action

Men Lie. Women Lie. Supply and Demand levels usually don't.

You probably remember learning “The Law of Supply & Demand” in an economics class at some point in your high school or college career. 

If you don’t remember, here’s a quick recap: 

 

 

The Law of Supply & Demand, a foundational theory in economics, explains the interaction between the sellers and the buyers for a resource. At any point in time, the supply of an item is fixed or is the upward slope while the demand curve is a downward slope due to the law of diminishing marginal utility. When both lines intersect, the point of intersection then becomes the equilibrium price. 

This theory generally operates on four rules:

  1. If demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price.

  2. If demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price.

  3. If demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price.

  4. If demand remains unchanged and supply decreases, a shortage occurs, leading to a higher equilibrium price.

So how does it relate to your life or routine? For example, when you go to the grocery store to check out the new brand of ice cream, your decision to buy or not buy affects the price of the ice cream. 

Similarly, the stock market also works this way but the supply and demand theory plays a much bigger role. When investing in stocks, you might often read or hear explanations to why stock prices rise and fall so randomly. While some influences such as earnings and the economy might affect your desirability to own or sell a particular stock, stock prices are also a function of supply and demand.

As the demand for a stock grows faster than the supply and more buyers move into the market, the price of that stock goes up accordingly. Eventually, the stock’s demand will exceed its supply causing the stock’s price to rise but only until buyers suspect the demand for the stock to diminish. At this point, holders of that stock may begin to sell their stocks, with some even hiking their prices up to make a profit while they are still ahead.

When these owners and holders begin to sell their shares and the stock’s price begins to fall, there's more supply than there's demand. To attract new buyers, sellers must lower their prices to adapt to the saturated market.

It’s a constant cycle. As technology advances and new products are released, our needs and wants change everyday as we try to adapt to a new generation or culture. One day we might want Product A, then the following day Product B is more affordable and labeled as “the next big thing.”

Next time you’re shopping in the grocery store or any store, look carefully for the new products on the shelves. Check that company’s stock prices to observe the interesting changes in the following months of a new product’s release. The prices will tell you the current story, the rest is just noise. 

vig.io Supply Demand
TagsGeneral InvestingTechnical AlgorithmsDeep Learning Behavioral FinanceBehavioral Economics Live Charts
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