How to Use Supply and Demand Zones in Crypto Trading

Mastering Supply and Demand Zones in Crypto Trading

Crypto markets are known for their violent price swings up and down, making it tricky for even pros to generate consistent profits. In this situation, applying an old but well-tested methodology can provide an additional edge in trading. One such concept is the supply and demand zone technique. These zones are areas on your BTC price chart where serious battles take place between bulls and bears, creating future reversal points. Let’s find out why supply and demand zones could be useful in crypto trading and exactly how you can deploy them in your crypto trading.

But what are supply and demand zones?
The core concepts of supply and demand zones are:

● Demand zone - Areas on the price chart where buyers overwhelm sellers, causing the price to rally.

● Supply zone - Ares, where sellers overpower buyers, triggering bearish reversals and rallies.

These zones are not a coincidence. They are created by large institutional players, also called “smart money”. These players can not instantly open their large trading orders and create accumulation and distribution zones. These zones also reflect psychological price levels where market sentiment shifts.

Supply and demand zones versus support and resistance

Zones versus lines is a long-held discussion. Every beginner has this question as they often get confused. Zones are broader areas, not single lines, accounting for market volatility. Supply and demand zones highlight imbalances in order flow, not just historical price points like support and resistance levels.

Why do they work in crypto?

Crypto markets tend to have lower liquidity. Unlike Forex markets, where trillions of dollars are traded daily, cryptos have much lower market capitalization. As a result, crypto’s low liquidity magnifies reactions in these zones. These reactions are amplified due to algorithmic trading and herd psychology.

How to spot supply and demand zones

Here is a step-by-step process to spot supply and demand zones on your crypto chart:

1. Find sharp price movements - Demand is where the price rises rapidly. Mark the base where the rally started. Supply zones are sharp price drops. Mark the origin where the price started to drop.

2. Draw the zone - Use horizontal rectangles to cover the base (demand) or top (supply) of the move. Ensure to include candles preceding the move.

It is crucial to only use strong supply and demand zones. Strong zones tend to have large candles that break out of consolidation. The faster the price departed, the stronger the zone. Zones that remained untouched for long periods of time remain potent and should not be overlooked.

Trading tactics using supply and demand

Many techniques employ supply and demand zones in trading, but we will cover the basics in this guide.

Entry rules

Generally, demand zones are where we look for long trades, and we sell at supply zones. One method is to buy when the price re-enters the zone with bullish reversal confirmations (candlestick patterns, engulfing, etc.). We sell short on bearish reversals like a shooting star, bearish engulfing, and so on. 

Stop-loss placement

In demand zones, where we seek to buy trades, the stop-loss is usually set below the zone’s low. Ensuring the stop-loss is several pips away from the zone is a good idea to give the price enough room for movement.

In supply zones, the stop-loss is set above the zone’s high, several pips away from the zone.

Take-profit targets

Since supply and demand zones do not have very high win rates, it is a good idea to use a 1:2 and even a 1:3 risk-reward ratio. This is because when you are right, you have to catch at least twice the pips to account for losses and trading costs such as spreads and commissions.

Filters to ensure high-probability trades

Using supply and demand zones as a standalone trading indicator is fruitless. In crypto markets where random movements are not rare, it is critical to use additional filters and confirmations. One good filter is to align your trades with the main trend using a 200-period exponential moving average. If the setup is also confirmed by volume spike, even better. However, the majority of supply and demand zone traders employ various indicators such as RSI divergences to confirm zones and only pick highly probable setups.

Overall, it is crucial to always confirm your supply and demand zone setups with additional filters and indicators for the best results.