In this section, I'll break down step-by-step how to determine the strength of a supply or demand zone by analyzing the preceding move and market sentiment before a zone formed.
**REMEMBER:**
The preceding move reveals how many retail traders were buying or selling before the zone formed.
The banks require masses of retail traders buying or selling to enter their own trades or secure profits.
Banks can't execute these actions without retail traders.
My point?
If we gauge the overall market sentiment (buying or selling) before the zone formed, we can estimate the size of the orders placed by the banks, giving us some idea of how powerful the zone is.
Ready to get started?
Let's jump in and look at step 1...
FIRST:
Find the zone you want to analyze.
Any zone will suffice—Supply or Demand. (This method works on all pairs and all timeframes.)
All supply and demand zones are suitable, too: Rally-Base-Rally/Drop-Base-Rally, etc. Just remember: RBR/DBD zones are usually weaker than RBD/DBR zones due to the short preceding move... (more on this later).
For this example, we’ll use a 1-hour supply zone on GBP/USD...
Nothing special about this supply zone; I haven't cherry-picked it. It just highlights the distinct phases of analysis; that's why I selected it.
Okay, NOW for the fun part...
To determine how powerful this supply zone may be, analyze the move BEFORE the zone formed...
What was the market sentiment at that time?
What were most retail traders thinking?
Were they bullish, bearish, or neutral?
To what degree; strongly bullish, slightly bearish?
Remember: Try to estimate how many retail traders were buying or selling before the supply zone formed. Put yourself in the typical retail trader's shoes and try to understand their outlook before the zone formed.
To do this, focus on two key points:
* The previous rise/decline duration before the zone developed?
* How bearish/bullish market sentiment was at that time?
This will help you understand how many retail traders were buying before the zone formed. Then you can assess the number (and size) of the buy orders entering the market before
the banks sold to create the zone.
The logic is simple:
If masses of retail traders were buying before the supply zone formed, the zone must be a formidable price barrier: The banks clearly sold to counter the buying coming in.
The HEAVIER the buying...
The MORE the banks had to sell.
THINK: How else could price fall with most traders buying?
Let's check the price action before the zone formed...
Moving the chart back a little... what do we see?
Right away, it's clear:
The market sentiment was STRONGLY bullish before the supply zone formed. Price had been rising heavily before the zone appeared, with only a few small pauses and retracements breaking up the action.
Also...
Check out the last move higher.
It's almost vertical!
Multiple large bullish candlesticks pushed price to new highs, duping thousands of retail traders into entering long - perfect timing for the banks. Since price was heavily bullish, this indicates retail traders were entering long before the zone formed, which suggests the zone holds significant power.
Now...
We must put ourselves in the shoes of the retail traders who were seeing this move.
What were they thinking during this time?
How bullish or bearish were they?
How to do this:
Adjust the chart to before the zone formed...
Now we can't see the supply zone itself, but we can see how the market appeared to traders at that time, which helps us understand the sentiment of what most traders were seeing (and feeling) about the market.
Like this...
See how the chart sits on the rise before the zone formed?
Now we can put ourselves in the minds of retail traders and see exactly what they were thinking before the supply zone formed.
It's obvious—price had been trending higher even before the upswing creating the zone took place, which adds further evidence most retail traders were STRONGLY bullish before the
zone developed.
The steep rise, followed by the upswing, enticed many to enter long. No recent price action suggested the market was about to turn and reverse lower.
Does a reversal seem imminent looking at this?
BOTTOM LINE: Before the supply zone formed, most retail traders were entering long. And that means: Banks had to enter MASSIVE sell positions to overwhelm the buyers and and create the supply zone.
Ask youself...
Who then sells when everyone is buying?
Who has that power in the market?
Of course, it's the BANKS!
Why would banks decide to sell in such high quantities? Because they expect price to REVERSE and begin falling.
Here's the takeaway:
From analyzing the duration of the preceding move, we can confidently say this supply zone has a high probability of causing a reversal; it developed from the banks placing massive sell positions into the market.
If I move the chart forward...
It plays out exactly as expected:
Once the price returns to the zone... a large reversal begins.
The banks created the supply zone by selling to all the traders who were buying due to the heavily bullish preceding move.
Then, the banks used these buyers to enter major sell trades.
That's why the price reversed and the zone formed!
Why did price return later?
Banks still had additional sell orders to enter around the same price—even with masses of buyers, banks can rarely enter significant positions all at once at a single price. Once these positions were executed, the real reversal got underway.
Simple.