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Seeing the supply/demand curve on a price chart
How do we know when we are at these levels, far from equilibrium? Please revert back to the first chart in this piece. Price levels "A" and "C" represent the boundaries of this curve. All you have to do is look at a larger time frame chart (or smaller if you're an active trader) and do the following:

1. Identify current price.
2. Identify the demand level below current price. This level represents the lower boundary of the supply and demand curve.
3. Identify the supply level above current price. This level represents the upper boundary of the supply and demand curve.

The Problems with Conventional Portfolio Diversification
For most investors, your portfolio is split between stocks and bonds. Whatever the split is, have you ever realized that almost every investment in a typical portfolio appreciates only when prices go up? What happens if these markets go down for a significant period like they did in Japan for over 10 years? And worse, what happens if this decline in price begins when you are near retirement?

When we break down portfolio diversification in stocks, there is another issue to be aware of. Your average investor will typically be told to reduce risk by investing portions of their portfolio in different stock sectors and markets. An example would be to have a portion of your stock portfolio in Dow stocks which are typically large cap stocks and a portion in the tech heavy NASDAQ market.

At first glance, these two charts appear to be the same chart. During almost any period in time, equity markets move in the same general direction. As you can see here, diversifying in these two markets is really not decreasing risk, it is actually increasing risk. The average investor thinks their hard earned capital is diversified properly between two semi-uncorrelated markets but the truth is, the risk is actually DOUBLED as these markets almost always move in the same direction. Again, conventional diversification is typically risk-disguised as opportunity for the ill-informed investor. These days, it is also very uncommon for a foreign equity market to move in the opposite direction of the major U.S. markets for any sustained period of time.

Proper Diversification According to the Laws of Supply and Demand

Ok, enough questions and alarming issues. Let's use pure supply and demand and learn how to properly diversify your portfolio. Notice the charts above. Here, we are looking at the same period of time in the S&P 500 and the 30 Year Bond. Area "A" in the S&P chart represents a major supply level for reasons mentioned prior in this piece. "B" is the first time price revisits that area of imbalance which is where we would want to sell for profits or initiate a short position. Let's take a look at the 30 Year Bond chart. Area "A" represents a major demand level, again, for reasons discussed earlier in this piece. "B" represents the low risk/high reward time to buy into the Bond market.

Take action when risk is lowest and reward is highest
As you can see, at the exact same period of time, the S&P begins its huge decline and the Bonds begin their enormous rise. The proper play for the astute diversifier is to take profits (sell) on much if not all of your stock holdings and buy into the bond market. This is how we diversify our portfolio based on the laws of supply and demand.

No matter how diverse your stock holdings were during that decline in the S&P, you likely lost plenty of your investment capital. Had you listened to the whispers of Adam Smith and focused on pure supply and demand, the move from stocks to bonds was very clear. Don't let the illusions of conventional thought obscure what is truly a simple reality that anyone can understand and apply.