Now comes the golden question: what causes supply/demand zones? Like Support and Resistance, it’s a self-fulfilling prophecy. However, the theory that’s become accepted in the trading world is institutional order flow. This is where Smart Money comes into play. What do we mean here? All traded markets are divided into retail traders (the average person) and institutional traders (the Smart Money).
Smart Money represents the biggest and most monied players, particularly banks. The belief is that these entities cause changes in Supply and Demand forces due to their enormous and unmatched trading power. Despite this, Smart Money traders cannot place their positions like retail traders because of the size. For every buyer, there needs to be a seller and vice versa. If you’re selling a mere standard forex lot, that’s a tiny size where there will always be demand to fulfil the order.
It’s a different story for groups trading hundreds of lots at a time. Fewer buyers will exist to meet the demand if you’re selling that much volume. So, only a tiny portion of your order would get filled. This causes the price to drop as the trading platform looks for buyers along the way to fulfil the rest. The problem is that such an occurrence produces a worse entry price, reducing the overall profit.
So, the solution is placing the huge position in smaller chunks around a similar price. Each execution pushes the market in the intended direction. The hope is that the market will return to the same area for the Smart Money to fill in the remainder of the order. This is because, by this time, thousands of traders would be on the opposite side, allowing for a favorable entry.
