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Supply & Demand Responsiveness

A price chart is simply a representation of supply and demand dynamics. When there are more buyers (demand) than sellers (supply), the market moves higher. Conversely, when there are more sellers than buyers, the market moves lower. When the number of buyers and sellers is roughly equal, the market tends to move sideways, indicating a point of equilibrium.


Support levels are characterized by a concentration of buyers, while resistance levels indicate a concentration of sellers.


We can objectively identify where buying and selling pressure is most active in the market by using gamma data.


The higher the gamma value, the more buying or selling pressure exists at that strike. In other words, the stronger the support or resistance level. Prices tend to gravitate towards strikes with higher gamma values. If the market breaches a level, it increases the likelihood of moving to the next supply or demand level.


Responsiveness

Supply and Demand, also known as Gamma Levels, are a significant variable in our process. We typically aim to enter positions at or around these major levels. While we cannot predict with absolute certainty whether the market will hold at that level, observing how price reacts to it can provide valuable insights into the true strength and potential market response.



Weak Scenario: If the market consolidates at a level for an extended period, indicating low demand, any ensuing rally is likely to be relatively small in magnitude, and the price is more likely to return to that level. The more times a level is tested, the more susceptible it is to a break.


Strong Scenario: Price may consolidate for a bar or two, but the level is highly responsive, indicating strong demand, with buyers stepping in as the market gains momentum.


Stronger Scenario: The level is highly responsive, often leading to immediate resolution and a sustained directional move characterized by consecutive directional candles. In this scenario, the market is unlikely to retest that level.


The same concept applies if you are analyzing supply at a resistance level.


Frequency of Touch & False Breaks

As mentioned above, the more times a level is tested, the more susceptible it is to breaking. Generally, the first or second test of a level is the best, while a third or fourth test is more likely to result in a breakout/breakdown and trend continuation. To stick with the topic of demand, if a level is tested and buyers are stepping in but continuously fail to see a positive resolution, buyers will become exhausted and start reducing their exposure or flipping directions.


A break would assume continuation to the next demand level; therefore, if you are positioned in that direction, you can view it as further confirmation. The market has the potential to false break a support level before reversing upwards. These false breaks are notably more frequent in a negative gamma state, as dealers tend to sell weakness and buy strength. However, a significant reason for these false breaks is rooted in the market's liquidity function, as it gravitates towards order flow, with many traders often positioning their stop orders just below the support level. Consequently, this scenario can trigger stops and the market reverses higher.


If you are trading against the trend, you may want to take these breaks more seriously. However, if you are trading with the larger trend, such as buying the dip in an uptrend, you may want to be more patient to ensure you don't get shaken out.


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