HOW TO DO A TOP-DOWN ANALYSIS USING THE SUPPLY-DEMAND METHODOLOGY
THE STEP BY STEP PROCESS
Doing a T-D analysis is critical for making decisions about taking a speculative position in the financial
markets. It is no more than looking at the same market from different perspectives.
For a detailed T-D analysis I use 3 timeframes. Each timeframe has its own purpose.
Each timeframe used should be a view of the markets from whatever perspective that particular
timeframe represents.
Each timeframe gives information that should be taken and put into a decision matrix to come out
with the most appropriate action that should be taken given the available information.
The most appropriate action is deliberate and implies that the decision is based on fact as obtained
from reading the chart.
As SUPPLY AND DEMAND traders (SAD traders!), we use the economic concepts of supply and demand
in interpreting market action.
THE STEPS
The first and most crucial step in doing a T-D analysis does not actually involve looking at charts. The
first step is making a personal decision about what type of trader you are.
By this I mean, deciding how you choose to look at the markets - are you a trader looking to make a
monthly income from trading?, a weekly income?, a daily income?, or maybe even a high frequency
trader..
This decision is critical because it is what determines what timeframes will be Top and down
timeframes in your Top-down analysis.
A weekly income trader will have to use the weekly chart as the top whilst a trader looking to make an
income daily must use the daily chart.
STEP 1: WHAT TYPE OF TRADER ARE YOU?
Once you decide what type of trader you are and only then can you go to work doing a T-D analysis.
Notice at this stage you have thus far only decided on one timeframe, your top timeframe.
This top timeframe in the S&D methodology is called THE CURVE TIMEFRAME.
The Purpose of the Curve:
To identify the location of current price in relation to the location of the larger timeframe supply and
the larger timeframe demand.
You are seeking to identify the nearest FRESH Demand zone below current price and the
nearest Supply zone above current price. This represents the CURRENT S/D curve
The term FRESH in the supply-demand methodology implies a zone of demand or supply that price
has not returned to at all since the zone was created. A zone that has even one retracement however
minimal the retracement, is no longer considered FRESH.
Steps to identify zones: As I put in my discussion last time about this, this is the method I learned to
identify demand and supply zones, regardless of what timeframe I am looking at.
To identify a Demand zone:
1. go down and left without cutting through any candles
2. Identify a strong rally in price
3. Trace this strong rally in price down to its origin and you have your base
To identify a Supply zone:
1. go up and left without cutting through any candles
2. Identify a strong drop in price
3. Trace this strong drop in price up to its origin and you have your base
Once you have finished identifying the nearest fresh SZ above current price and the nearest fresh
demand zone below current price you have pretty much completed your assessment of this
timeframes view of that market.
There are other nuances for the curve timeframe that I cant go into in detail in this post such as the
trend on the curve timeframe and how it ties into the zones and the appropriate action to take,
depending on where price is on the curve.
However, regardless of these nuances, by identifying the nearest fresh SZ above current
price and the nearest fresh demand zone below current price, what you have done is
identify an area above current price that you do not want to be a buyer at and an area
below current price that you do not want to be a seller at. That is critical information.
The second chart is my TREND CHART.
I know you are probably thinking, what is AKT talking about, I thought we look at trend on all
timeframes? We do.
However, trend analysis on each timeframe has different purpose and provides different pieces of
information.
Continuing on the Curve for a little bit longer.
Once you have identified the nearest fresh demand below price and the nearest fresh supply above
price the next step is to decide what the most appropriate action is for you as a trader to take.
To be able to make this judgement, you need 2 things
First where is price relative to the SZ above and demand zone below on this curve chart?
Close to or at Supply most appropriate action (which will be taken on the lower timeframes) is to exit
longs and start looking for opportunities to sell. Notice I did not say sell straight away because you are
near supply. I said start looking for opportunities to sell. You may get these opportunities if they arise.
They may not. For example, in cases where the S-D curve is shifting.
Close to or at Demand most appropriate action is to exit shorts and start looking for opportunities to
buy.Opportunities may or may not arise. You mustn’t buy blindly just because price is at HTF demand.
Please notice that I have not mentioned anything yet about the trend on the curve timeframe.
That is deliberate. -- intentionally
The reason is that although we must look at trend on this timeframe, trend is not the primary function
of this chart (Curve)
I will tell you why using an example.
Say you have done your curve analysis, identified supply above and demand below current price.
You find that price is close to or at the curve timeframe demand zone.
Next you ask the question, what is the trend on the curve timeframe?
You do your analysis of what zones are being respected and what zones are being violated and you
conclude it is a downtrend.
What now?
Are you going to sell because it is a downtrend? If you do, the odds are the trade will not work.
The is because you are at a HTF demand zone, area where the chart objectively has told us that
demand exceeds supply.
What then is the most appropriate action to take?
If you were short from above and are now close to or at curve timeframe demand, exit your shorts
If you not in any trade, now is not the time to be looking for a short because of where you are on the
curve.
Either wait for price to rally to the curve timeframe supply AND THEN join the downtrend Or
Start looking for opportunities to buy, knowing that your buys will be counter trend (counter to the
trend on the curve timeframe).
So, trend is important in the curve timeframe but it is secondary to the location of price which is the
most important purpose of the curve timeframe chart.
What about when price is neither close to demand nor close to supply? This is called Equilibrium.
Supply and Demand are considered to be IN balance in this area (notice I did not say IM-balance)
In this area where S&D are in balance you have 2 choices.
1. Either stay totally out of that market because S&D is IN balance Or
2. Join the trend on your middle timeframe, not the trend on the curve timeframe please.
If you decide to go with option 2 be prepared to take your profits off the table quickly because
remember, this is a region where both supply and demand zones are likely to work.
A DISCUSSION ABOUT TRENDS
It is a topic that divides most traders.
There are countless ways traders define trend – moving averages, ADX, price action, etc.
For SAD traders, we use the inter-relationship between supply and demand zones to define trends.
Supply zones being created and respected = Downtrend
Demand zones being created and respected = Uptrend
A definition of trend that has totally changed how I look at them is this:
Trends are only the movement of price between higher timeframe supply and demand levels.
If price is moving from HTF supply to HTF demand we are in a downtrend.
By this definition, once identified the Curve SZ and the curve DZ then to the second chart, the trend
chart, to determine the trend on that chart, the middle chart of my sequence of 3, the intermediate.
By its very definition, a trend is something that has already happened. It is only recognised after the
fact.
Now, what causes the most confusion is deciding on a trade direction once the trend direction is
determined. We have all heard the age-old trading phrase, “The trend is your friend” and others like
“Don’t fight the trend”, “Don’t try to catch a falling knife” etc.
“The trend is your friend, UNTIL THE BEND AT THE END”.
To add to Ed Seykota’s point, another legendary and extremely wealthy trader, Paul Tudor Jones said
the following about trends in general, “I believe the very best money is made at the market
turns. Everyone says you get killed trying to pick tops and bottoms and you make all your
money by playing the trend in the middle. Well for twelve years I have been missing the
meat in the middle but I have made a lot of money at tops and bottoms”.
So it is for this reason that it is critical that we know where we are on the CURVE before we
go ahead to follow any trend and not just follow the trend blindly.
In the supply demand methodology it is at this point that the concept of “Zone in control” comes in.
If price is at an extreme i.e. at either curve timeframe supply or curve timeframe demand then that
zone is said to be in control (if at curve supply zone then that zone is in control; if at curve timeframe
demand then demand is in control)
To stop an uptrend, you need a “mass” of sellers and for there to be no more buyers (a loss of buying
momentum).
We can only find enough of a mass of sellers on a timeframe higher than the one we are looking at the
trend on.
We assess momentum or acceleration using trend lines as taught by Alfonso
The combination of finding enough of a mass of sellers (arriving at the larger timeframe supply zone),
the lack of more buyers and the loss of momentum shown by a trend line break tells us that the trend
is no longer up and may soon become down.
PICTURES OF SUPPLY AND DEMAND
PICTURES OF SUPPLY:
There are only 2 pictures that depict supply on a price chart.
Both pictures have two things in common, they both have bases and they both have drops after the
bases.
Picture 1 of supply: RALLY BASE DROP
This type of supply zone is a reversal pattern which implies they are best used when we are looking
for a zone for a potential reversal of a pre-existing downtrend to kick off. They are usually found out
at the extremes of moves and can be quite powerful.
The one downside to using this type of supply zone is that they are usually not authentic zones (more
on zone authenticity later). They tend to be pullbacks into zones represented by the second picture of
supply, the DROP BASE- DROP.
Picture 2 of supply: DROP BASE - DROP
This type of supply zone is a continuation pattern which by definition implies that they are best used
when there is a trend underway (hence why the pattern is a continuation pattern, i.e. continuing a
pre-existing trend).
They are usually found in the middle of the curve (again, this is why they are linked to trends because
remember what we do in the equilibrium area? we follow the trend!)
They do not work as well for trend reversals UNLESS they are embedded within the larger timeframe
zone. For example, say you use the monthly chart as your curve timeframe and price has now arrived
at monthly supply. You know you are the extreme of the curve and should be looking for opportunities
to sell. Since the monthly SZ is too wide for you to use as an entry zone, you take an X-Ray of that
monthly SZ to take a closer look inside it. This X-ray is taken using your daily lens, your daily
timeframe.
Look and behold, you find embedded within the monthly SZ, a daily DROP-BASE-DROP SZ.
You have just found your entry.
PICTURES OF DEMAND:
There are only 2 pictures that depict demand on a price chart.
Both pictures have two things in common, they both have bases and they both have rallies after the
bases.
This type of demand zone is a reversal pattern which implies they are best used when we are looking
for a zone for a potential trend reversal to kick off. Reversal of what you may ask? Reversal of a preexisting downtrend. Like their They are usually found out at the extremes of moves and can be quite
powerful.
The one downside to using this type of supply zone is that they are usually not authentic zones (more
on zone authenticity later). They tend to be pullbacks into zones represented by the second picture of
supply, the DROP BASE- DROP.
Picture 2 of Demand: RALLY - BASE RALLY
This type of Demand zone like its counterpart supply zone, the DBD, is also a continuation pattern
which by definition implies that they are best used when there is a trend underway (hence why the
pattern is a continuation pattern, i.e. continuing a pre-existing trend).
They are usually found in the middle of the curve rather than at extremes (again, this is why they are
linked to trends because remember what we do in the equilibrium area (the middle of the curve)? we
follow the trend!)
They do not work as well for trend reversals UNLESS they are embedded within the larger timeframe
zone.
So there you have it, the 4 patterns supply and demand traders use in entering and exiting the
financial markets. No matter what market it is, we are looking for these patterns over and over again.
Before we go over the steps we take in identifying any of these 4 patterns, a word about the concept
of the flip zone.
THE FLIP CONCEPT DEFINED:
The concept of the flip zone is based on the age-old technical analysis mantra of what was once
support becoming resistance and what was once resistance becoming support.
The slight supply-demand twist to this more conventional thinking suggests that a new zone of
opposing polarity is usually created in the process of taking out a supply or demand zone.
If a supply zone is what was taken out then a demand zone should be created in and around the same
area of the supply zone
If a demand zone is what was removed then a supply zone should be created in and around the same
area of demand
See chart examples below for both scenarios
TOP time frame the weekly chart.
Trend chart will be the daily chart
My entry time frame will be the 4hr chart
ZONE QUALITY ASSESSMENT
To summarize what we have discussed thus far;
We now know what patterns we are looking for on a price chart, that represent Supply and demand,
and how to identify these patterns or zones.
We also now know what a flip zone is and how the 2 types are formed (i.e. the flip zone of supply and
the flip zone of demand).
The next step is to assess the quality of the zone (s) to help us decide if they are of high quality.
So, what makes up even consider a zone a zone?
Well, the most obvious thing that draws us to zones is the move away from a level.
Remember how we identify supply above and demand below starting with current price, look up and
left for supply and down and left for demand.
We are looking for big moves in price, down for supply, and up, for demand.
1st odds enhancer to be assessed is:
Strength of Move away from a price level
How did price leave the level?
Strong departure (think of it like a NASA rocket taking off) i.e. large ERC candles or a gap away from
the level scored as a 2 (gap away it is the biggest representation of an imbalance in supply and
demand. We don’t often get then in FX compared to stocks for example).
Medium Departure (those were usually fired at an angle rather than space rockets that go vertical into
the atmosphere) scored as a 1
Weak Departure. The candles leaving the zone are usually weak and a mixture of up candles and down
candles. Scored a 0.
The 2nd odds enhancer Curve Location
Where is the zone is located relative to the curve timeframe supply and demand zones?
A demand zone (DBR & RBR) located low on the curve 2
A demand zone located in the middle of the curve 1
A demand zone located high on the curve 0
A supply zone (RBD & DBD) located high on the curve 2
A supply zone located in the middle of the curve 1
A supply zone located low on the curve 0
The 3rd odds enhancer Profit potential
If I trade at this zone and it goes my way, how much distance do I have on my entry time frame to
the next opposing level?
So if I buy in demand, where is the nearest supply zone? (Remember, this applies to the first target
only) If I sell in supply, where is the nearest demand zone?
Opposing zone 3:1 distance away? scored 2; Opposing zone 2:1 distance away? scored 1;
Opposing zone less than or equal to 1:1 distance away scored as a 0
The 4th odds enhancer Freshness
Since this zone was created, how many times has price returned to the zone?
No return to the zone as yet scored a 2
At least one return but no penetration beyond 25% of the width of the zone 1.5
At least one return with a greater than 25% penetration but less than 50% penetration 1
At least one return with >50% penetration 0
The 5th odds enhancer Time spent at the level
How many candles are in the base of the zone?
< 6 candles in the base scored a 1
>6 candles in the base scored a 0
Other odds enhancers SAD traders use include
{C}1. Arrival of price back to the level i.e. did price return sharply (a good thing) or did it do a slow
laborious return (not a good thing) I don’t use this odds enhancer because I am a set and forget
trader and so I am not usually in front of my charts when prices arrive anyway
{C}2. Session the zone was created in in FX a zone created in the European session or New York
session is more likely to be stronger than that created in the Asian session because of the differences
in volume of trade across sessions. Asia usually has the lowest volume
{C}3. Dollar index. For some traders this is a must have and ranks high on their list. Me personally, I
have not found it that useful.
I know it is important to know what the dollar is doing so I usually do a dollar analysis first each day
but I don’t base my trade entries solely on what the dollar is doing.
{C}4. Correlations. So called commodity currencies like the AUD, CAD, NZD can be used as an
additional odds enhancer when compared to the commodity they are most aligned to.
CAD + Crude oil
AUD + Gold
For example, it would be more likely for an AUD based pair buy to work if gold was entering or in a
demand zone on its chart as well