The Two Types Of Supply And Demand Zone

Anyone who’s learned to how to trade supply and demand from Sam Seiden will know about the two types of zone he looks for in the market, what Seiden doesn’t talk about is the differences between these two types of zone and why they form in the market.

Knowing why the two types of zone form holds the key to taking more successful supply and demand zone trades. We are going to take a look at the two types of zone today, I’ll give the people who may not know what the two types of zones are a quick guide to bring them up to speed and then I’ll explain what causes each of the two types of zone to form in the market.

 

Sam Seiden’s Two Types Of Supply And Demand Zone

 

When first learning about supply and demand trading from Sam Seiden it’s likely you would have come across his articles on the two ways he classifies a supply or demand zone.

These zones are classified based on where they form in the market, if a supply or demand zone forms during a trending move then it’s either a drop-base-drop or rally-base-rally. A zone created at a trend reversal is either a rally-base-drop or a drop-base-rally.

For those who don’t know what the different zones listed above look like on a chart I’m going to give you a quick run through so you can see the differences for yourselves.

Rally – Base – Rally

image of rally-base-rally demand zone

The rally-base-rally is a type of demand zone which forms during an up-move.

They get their name from the market structure which creates the demand zone. In the example above you can see first we have a rally, then a consolidation, ( which Sam calls the base ) and finally another rally which creates the demand zone itself.

A rally-base-rally will always form a demand zone, they never create a supply zone.

Note:

The demand zone in the image above is drawn in terms of how Sam draws the zones, I mark them differently using the guidelines laid out in this article.

Drop – Base – Drop

image of drop-base-drop supply zone

The drop-base-drop is the exact opposite of a rally-base-rally, with the only similarity being they both form during trending movements.

Whereas a rally-base-rally structure will always form a demand zone in the market, a drop-base-drop will always form a  supply zone.

Both the drop-base-drop and rally-base-rally supply and demand zones are categorically the same, they both only form when the market is trending and they are zones which if the market returns to should push the price back in the direction of the movement which created the zone.

In the image above a drop lower created the supply zone so if the market was to return to this zone it should push the market lower.

Now we’ve covered what drop-base-drop and rally-base-rally zones look like, we’ll now take a look at the other type of supply and demand zone Sam uses…….

Drop – Base – Rally

image of drop-base-rally demand zone

The drop -base-rally is a structure which always forms a demand zone in the market.

These zones differ from what we have just looked at mainly because of their location in the market, whereas both rally-base-rally and drop-base-drop zones only form during trending movements drop-base-rally zones will only be found when the market changes from moving down to moving up.

If the market was to return to the drop-base-rally demand zone it should push the market in the direction of the rally which created the zone.

Rally – Base – Drop

image of rally-base-drop supply zone

On the opposite side of the scale we have rally-base-drop zones.

These zones form when the market reverses from moving higher to moving lower, when their construction is complete a supply zone will have formed in the market which if returned to should cause the market to fall.

Note:

It’s important to mention when Sam Seiden says BASE he means a small pause or consolidation, we do not need to see the same thing when looking for rally-base-drop/ drop-base-rally zones. For example, as long as the market makes a move up then drops the zone is still considered a rally-base-drop even though a pause or consolidation has not taken place in between the up and down moves.

image of demand zone without a base

The demand zone formed by the drop-base-rally above is considered a drop-base-rally zone even though no consolidation or pause has taken place which Sam Seiden would see as a base. When you see drop-base-rally/rally-base-drop zones like this which do not have a multi-candle base and instead only have a two candle base, they are still valid for trading even though their construction is slightly different.

 

What Creates Drop – Base – Drop/Rally – Base – Rally Zones ?

 

Both the drop-base-drop/rally-base-rally types of zone form in the market because of bank traders taking profits off existing trading positions.

image of rally-base-rally demand zone created by profit taking

Here’s the rally-base-rally zone I showed you at the beginning of the article.

Before the first rally we had bank traders placing long trades in the consolidation. When the banks buy orders consumed the retail traders sell orders the market rallied higher, now the bank traders are in profitable trades the next thing they’ll want to do is secure some of their profits. When they decide to do this they consume all of the buy orders coming into the market from retail traders who are have begun entering long trades due to size of the rally.

The consumption of buy orders means the market makes a small move lower, this creates the base which the demand zone eventually forms off. The move lower causes a large number of retail traders who went long on the rally higher to close their trades at a loss which puts a lot of sell orders into the market.

In addition to this, there will be a small number of retail traders who think the move down is a trend reversal meaning they’ll place sell trades with the expectation that the market is going to move lower.

With two sets of retail traders putting the same type of order in the market ( sells )  the banks now begin buying again knowing they’ll make the market move higher and in the process cause anybody who sold on the move lower to close their trades at a loss which ends up being the bank traders profit.

Note:

The size of the long trades the bank traders can place is dependent on how big the pullback or consolidation caused by the profit taking is.

In the example above the market only manages to pause for small length of time which means the banks are only able to place a small number of buy trades. If the profit taking caused a big pullback down to the 50% retracement level of the initial rally higher, the banks would have been able to place much bigger buy trades because more retail traders would have been selling and its likely the second rally would have continued for significantly longer amount of time.

For the other type of supply and demand zone i.e  ( drop-base-drop ) the exact same process outlined above takes place only the other way around.

The banks take profits off sell positions which stops the market from falling, then as the market begins to pullback against the trend the retail traders who sold late into the down-move close their trades at a loss, and reversal traders begin placing buy trades because they believe the trend is changing. Both of these traders are putting buy orders into the market the banks use to get more sell trades placed which eventually causes the market to drop and makes all the traders who placed buy trades to lose money.

 

What Creates Rally – Base – Drop/Drop – Base – Rally Zones ?

 

Whereas rally-base-rally and drop-base-drop zones can only form due to profit taking by bank traders, the drop-base-rally and rally-base-drop zones can be created by bank traders either placing trades to make the market reverse or by taking profits off existing trading positions.

The rally-base-drop/ drop-base-rally zones which form due to bank traders taking profits have a lower probability of resulting in a successful trades than zones that are created because of bank traders placing trades.

To understand why we must look at the intentions of the bank traders when they are placing trades.

image of drop-base-rally demand zone created by bank traders placing trades

If a bank is placing trades in order to make other traders lose money, the area at which they have placed their trades is important as they have a vested interest in keeping the market price from breaking the area. In supply and demand trading this means when a rally-base-drop or drop-base-rally zone is created by bank traders placing trades, the banks must keep the market from moving past the point where they have entered their positions in order to protect the trades they have placed.

In the example above we can see a drop-base-rally zone form after the market has been falling, its likely there were a large percentage of retail traders entering into short trades at this point which meant there was a lot of profit to be made by the banks if they came into the market and caused a reversal.

When the banks enter into their long trades they consume all the sell orders coming into the market and the price begins to climb, eventually breaking the swing high found at the top of the last move lower.

Soon after the break of the high we see a large drop take place, this drop causes a lot of retail traders to start shorting again due to them believing the move higher was simply just a pullback to the downtrend. When the market comes into contact with the demand zone which was created by the first bout of buying from the banks they’ll buy again to get more trades placed in the direction of the reversal.

If the banks didn’t buy and the market fell below the demand zone then they would be put at a loss on their positions and would have to liquidate their buy trades. Of course it’s highly unlikely for this to happen because the banks always make sure to iplan their trades in advance.

The main problem with drop-base-rally/rally -base-drop zones is determining if the zone has been created by banks placing trades to make people lose money or by taking profits off their own positions.

 

Structure Of The Rally – Base – Drop/Drop – Base – Rally Zones

 

To find out whether the zone you’re looking at has been created due to profit taking or from bank traders placing trades requires you to be able to understand the mechanics of where the supply or demand zone has formed in relation to the current trend on the time-frame you’re observing.

The first piece of market structure in a rally-base-drop zone is a rally, in drop-base-rally zones it’s a drop.

Analysis of the rally/drop is what will give us clues in figuring out for what reason the zone has been created. The size of the candlesticks which form the rally/drop along with understanding where the wicks are on the candles themselves can give us the majority of the information needed to find out what the zone was created by.

image of demand zone caused by bank traders placing trades

Check out the rally which took place at the end of this down-move.

This move up occurred due to professional traders placing buy traders to make retail traders lose, the way I can determine this is by looking at the previous moves up ( marked with X’s ) in the down-move.

All of the previous up-moves which took place before the rally I’ve marked with the lines did not move up in a strong way, the bullish candles they were constructed of were either small or had wicks present on the top of the candle which shows us someone was selling even though market was moving higher, each one of these up-moves were created by bank traders taking profits off sell positions.

Now if we look at the final up-move we can see the rally was much greater in size than the previous up-moves which took place beforehand, this is mainly due to the size of the three bullish candles which made up the rally itself. These candles were far greater in size than the bull candles which the other up-moves were constructed of, this means the retail traders who were selling before the rally occurred had their trades turn from being at a small profit too being at a loss much quicker than the traders who would have been selling on the down-moves seem before the other up-moves which I marked with an X in the image.

With so many traders liquidating losing trades the banks make a large profit even from the market only moving a small distance, since the banks have already made a profit from making the retail traders lose they might as well make even more profit by placing more buy trades, there’s no point in them making a small profit when they can push the market higher and make an even bigger profit.

Aviary Photo_131045064134898436

Here’s an example of a drop-base-rally which didn’t work out successfully.

Why It didn’t work out was because both the base and the rally were created by profit taking from the professional traders who sold at the top of the move lower. While the drop lower was big in terms of overall pip movement, it was not a movement which went on for a long time like we saw in the other example which meant there would not have been a large percentage of retail traders placing short trades.

No matter how big the rally is in a drop-base-rally zone or the down-move is a rally-base-drop zone, if the market has not been trending in the same direction for a long enough time its unlikely for the zone to result in you having a successful trade.

The banks will only cause a reversal when there are enough retail traders for them to make a lot of money off, the appearance of a supply or demand zone when the market has only been moving in the same direction for a short length of time means there will not be many retail traders entering trades, therefore the banks will not be able to make a lot of money if they cause the market to reverse as only a small amount of traders will be liquidating their losing trades.

image of demand zone

Here’s another drop-base-rally zone.

There are two things which made this drop-base-rally a decent trade…

The first was the rally out of the zone, the candles which made up the rally were bullish large range candles which pushed the market a large distance against the previous down-move, these bull candles contain very little selling meaning its unlikely the banks where placing sell trades as the market rallied higher.

The second thing was the fact the rally managed to break the most recent swing high.

If you plan to trade rally-base-drop/drop-base-rally zones the best piece of advice I can give you is make sure the zone your trading breaks a recent swing high for drop-base-rally zones or a recent swing low for rally-base-drop zones.

If the rally in a drop-base-rally zone manages to penetrate an old swing high there is a much higher chance the zone will result in you having a successful trade than if no swing high was broken. The same rings true for rally-base-drop zones, If the drop pushes the market below a recently formed swing low there is a high probability of the zone working out profitably.

The reason why a break of a swing low or high gives the zone a better chance of working out, is partly down to the retail traders who enter into long or short trades on the candle which breaks the swing high or low. When the market breaches a high/low retail traders using technical analysis will know a possible trend change is taking place as the majority of traders primarily use higher highs and lower lows to determine current trend direction.

In the image you can see the market was falling until the rally broke the previous swing high, retail traders would have seen this and thought the market is changing from a down-move to an up-move, therefore after the market has hit the demand zone and is proceeding to move higher, before the swing high is broken large numbers of retail traders are placing long trades expecting the swing high to be broken which adds more buy orders into the market and thus increases the chance the swing high will actually be broken.

Another factor to consider is the retail traders who get trapped in losing trades when the market makes a new swing high or low.

When the market is in close proximity to a swing high or low breakout traders will place pending orders at the high or low expecting a breakout to occur, the movement which penetrates the high/low executes their pending orders and they are entered into their trades.

As the price fails to continue moving in the direction of the break and begins falling in the other direction, the breakout traders will become trapped in their now unprofitable trades, the point where these traders will end up closing their losing trades is often times right at the point where the move which broke the high or low originated from i.e a demand or supply zone.

When the breakout traders closing their losing trades a large number of buy/sell orders will come into the market which the bank traders will use to get more trades placed in the direction of the reversal.

 

Summary

I hope its clear from the article that the two types of supply and demand zone Sam Seiden uses in his trading are very different, not only in terms of why they form in the market, but also the construction of the zones themselves. If I remember correctly in one of Sam’s articles he also says the rally-base-drop and drop-base-rally zones have a higher probability of giving you a successful trade than the drop-base-drop/rally-base-rally zones although he neglects to give you a reason why this is. (probably because he doesn’t know)

Thanks for reading, please leave any questions in the comment section below.

Get My 6461 Word Book On Supply And Demand Trading To Learn......

  • How Old Supply And Demand Zones Do Not Cause The Market To Reverse And The Reason Why Traders Mistakenly Believe They Do
  • Why The Time It Takes For The Market To Return To A Supply Or Demand Zone Will Determine Weather The Zone Has A High Chance Of Causing A Reversal To Take Place
  • The Differences Between Zones Created By Bank Traders Taking Profits And Zones Created by The Bank Traders Placing Trades

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3 comments

  1. sutharsan

    Great Article, explains detail behind the Reversal and continuation. This is great tip for the supply and demand trader.

  2. Opa-Opa

    Then arent we back to the idea that when you see big, long bullish and or bearish candle/s go for it, place your order to that direction?… I am just struggling to understand which aproach is correct, since in your other article you said that its not a good idea to run after big candles. Please help

  3. AUGUSTINE SHUBAS GOMES

    SIR,
    GOOD DAY TO YOU. WHILE GOOGLEING SUPPLY DEMAND TRADING STRATEGY I READ ABOUT THIS TOPIC IN YOUR WEBSITE. I LIKE TO SAY A BIG “THANK YOU” FOR ALL THE VALUABLE INFORMATION YOU MENTIONED. ALTHOUGH I DO NOT TRADE IN FOREX BUT I DO TRADE IN STOCKS AND FNO. MY SALUTE TO YOU AND WARM REGARDS. HAVE A NICE DAY SIR. I AM LOOKING FORWARD TO LEARNING MORE FROM YOU IN COMING TIMES. HAVE A NICE DAY SIR.WARM REGARDS,

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