Supply and demand are more complex than most traders and economists give them credit for. I think most people view supply as “people selling” and demand as “people buying”. However, there are 2 distinct forms of market participation: passive market forces through the limit order book, and active market forces from market orders. Moreover, these 2 forms exist on both sides of the market.

Because of this, I propose that the term “supply” be used to denote the passive, limit order book forces on both sides of the market, and the term “demand” be used to denote the active, market-order forces on both sides of the market. So there can be both “asset supply” (limit orders to sell an asset) and “dollar supply” (limit orders to buy an asset for dollars). Likewise, there can be both “asset demand” (market orders to remove existing asset  supply / sell limit orders) and “dollar demand” (market orders to remove existing dollar supply / buy limit orders).

This morning I’ve been thinking through different supply & demand combinations, or general conditions that a market could be in, and this is what I’ve come up with so far:

The supply & demand matrix. In the margins, passive forces are denoted by darker red and green colors, and active forces by brighter red and green colors. Expected price behaviors are shown in the center of the matrix.

So it’s definitely more than just “supply and demand”. However, I think even this is an oversimplification as well, though perhaps more useful than what’s out there currently.

Another dimension that isn’t touched on here is the fact that demand for dollars, or money in general, is always stronger than demand for the asset … this is what makes it money. So this may actually skew the matrix more in favor of downtrends than what is suggested here. This is, in affect, the reason that “bulls take the stairs but bears go down the elevator” — markets fall faster than they climb — because the panic into money or demand for money is a stronger psychological force than the demand for assets is.

A couple of takeaways from this matrix would be:

• There are “safe spaces” on this matrix. For instance, pensioners and retirees should only be involved in markets that have strong dollar supplies (ready dollar liquidity when they need to exit a position to live off of savings). This can be independent of whether a market is in a trend or not.
• Long traders should try to only be involved in markets that are on the far lower right corner. But not all trends are “safe” for longs, even if they are moving upward in general.
• Short traders should likewise try to only be involved in markets that are on the far upper left corner, and not all down trends are “safe” for shorts even if they generally move in the right direction.