What Is The Bitcoin Rainbow Chart, And How Does It Work?

Since its first appearance, Bitcoin has seen incredible growth and is a highly volatile asset class. Its high returns result in a sharp increase in BTC investors yearly. With this development, many tools have emerged to gauge the price direction of Bitcoin. Even though we cannot count on a scientific method to buy or sell BTC, there are a few ways to grasp better its volatility which can help us make informed investment decisions. One of the ways we talk about here is using the Bitcoin Rainbow Chart. So what is the Bitcoin Rainbow Chart? How can the Bitcoin Rainbow Chart help us make the right investment decision? Let’s take a closer look at it, shall we?


What is the Bitcoin Rainbow Chart?

Bitcoin Rainbow Chart or BTC rainbow price chart represents a basic algorithmic regression chart. It depicts the price movement of Bitcoin. This chart includes colored bands to determine the right time to trade Bitcoin. The color of the lower boundary of the Rainbow is blue. It indicates that the price of Bitcoin is falling, while red represents its upper boundary, which means its price is rising.

It’s a long-term evaluation tool for providing perspective on an investor’s Bitcoin buying or selling strategy  based on crypto market sentiment in each rainbow-colored period.

  • Blue: BTC is in a bearish run
  • Light blue: buying area
  • Green: Cheap accumulation buy zone
  • Light green: the BTC price is still in the buy zone
  • Yellow: Hold BTC
  • Light orange: 50/50 .condition
  • Dark orange: FOMO is on the rise
  • Red: Consider taking profits.
  • Dark Red: In extreme FOMO condition and should take profit.
  • Interestingly, since 1, the price of BTC has never gone below the blue line at the bottom of the Rainbow.


How does Rainbow Chart work?

(Click on image to enlarge)



Bitcoin rainbow chart

 As you may already know, the moving average represents a trend-following tool. The Rainbow moving average represents combined moving averages of various, plotted on one price chart.

Their point of convergence of these MAs can therefore indicate a price reversal. Then it helps estimate the strength of the trend. Remember that if there are more lines used, the longer the time the indicator takes to show a “complete reversal” (a convergence of several moving averages).

There are several ways to use the Rainbow. First, it can be combined with other technical analysis tools as a trend-following indicator. When you encounter a strong trend (as identified by the Rainbow) while the indicator for entry points shows a bullish signal, you can consider opening a position BUY.

Suppose a strong trend (as identified by the Rainbow) and the indicator you are using to determine entry points sends a bearish signal. In that case traders consider opening a sell position. When the trend is weak, traders usually refrain from opening new positions.

There are multiple ways of utilizing Rainbow. First, it tends to be joined with other specialized analytics indicators. It’s usually combined with the trend following indicator.


Advantages and disadvantages of rainbow charts

  • Advantages

Since its launch, the rainbow map has always kept its accuracy.

Logarithmic regression models are handy when investing in relatively volatile assets.

The rainbow chart is easier to understand, even for a novice.

  • Downsides

The chart only shows the long-term price trend.

The rainbow chart has been accurate since launch, but in the future, it might be wrong without warning.

More time is needed to prove accuracy.

Should rainbow charts be used to identify trends?

Although, since its launch, the BTC Rainbow Chart turned out to be an effective indicator of volatility and market changes across the chart, it is not an indicator of the future price of Bitcoin.

A rainbow chart might not be the only thing we use to make our future investment decisions. Still, the insights we gain by looking at long-term price movements can help us better understand a particular cryptocurrency’s volatility.


How to read the Bitcoin Rainbow Chart

(Click on image to enlarge)

Rainbow Chart

Source: tradingview.com

The colored bands of the Bitcoin rainbow chart show the moment when the cryptocurrency is oversold and overbought. Moving up the band, the colors change to yellow, orange, and red. The bottom of the band shows when Bitcoin is oversold, represented by the colors blue and green.

The blue and green zones show the appropriate times to buy Bitcoin. Investors wishing to hoard would do so when the price is in those areas. When the price gets to the yellow, orange, and red areas, it would be a signal for investors to sell.

However, a study of the graph also reveals an interesting evolution in the price of cryptocurrency. Over time, a price considered expensive today may turn out to be cheap later on. In 2013, Bitcoin’sBitcoin’s price hit an all-time high of $ 1,000, and some investors thought it had gotten too expensive.

In 2017, the cryptocurrency hit another peak at $ 20,000, and a price that seemed too expensive five years ago seemed cheap. It remains to wait for how it will evolve in the coming years.


Rainbow Chart History

The Bitcoin Rainbow chart was first introduced by Reddit user Azop back in 2014. He added it to the Trololo logarithmic regression used for the estimation of Bitcoinćs value.

However, the expression “rainbow chart” itself was created by financial expert Mark Rubinstein. Describing many trading styles in his book, he uses the metaphor of the Rainbow. He compares the multiple colors of the Rainbow with the contacts of multiple assets.

Also, Mark Rubinstein ranks rainbow derivatives by their number of assets; a “two-color rainbow” represents a derivative based on two underlying assets, a “three-color rainbow” represents a derivative with three underlying assets, etc.


Other indicators combined with the Bitcoin rainbow indicator

(Click on image to enlarge)

Rainbow Chart

Source: xtrading.com

Other indicators combined with the Bitcoin rainbow indicator give the best insight into price movements. Here are some of the most often used indicators along with BTC Rainbow.

  • Volume indicator

Volumes allow us to know the behavior of investors and traders. This tool is used to display the volumes of sale and purchase transactions on Bitcoin, for example, which corresponds to the number of Bitcoins that are exchanged over a given period. Volumes are displayed directly on the chart and are represented by vertical colored bars.

A buy volume is represented by a green-colored bar, and a selling volume is represented by a red-colored bar.

Representation of purchase and sales volumes

Volumes help to know the sentiment of investors and traders in the market because they allow us to know if a stock is bought or sold.

A representation of volume is given for each candle, regardless of the time frame that is selected.

  • The standard deviation indicator

For example, the standard deviation measures the dispersion of the value of an index or a share. This dispersion is the volatility of the price.

This tool, therefore, makes it possible to show that price movements in the short term can help predict price volatility in the future.

The standard deviation measures the difference between the current price and the average price.

  • Trend indicator

Trends are used to define the direction in which the price of an asset is heading. There are three types of trends:

  1. The horizontal trend

Corresponds to a range and appears when the price of a Bitcoin, for example, oscillates between Bitcoin prices that are similar for a certain period of time.

It will be represented by a horizontal line and will actually represent areas of support or resistance.

     2. The uptrend

It appears when the price of Ethereum, for example, reaches higher and higher highs.

It will be represented by a line that will start from a low point to a high point.

     3. The downtrend

It appears when the price of a stock, for example, hits lower and lower lows.

Will be represented by a line that will go from a high point to a low point.

To represent a trendline on a chart, you need to connect the peaks or troughs to each other.

For a trend to be validated, several characteristics must be respected:

It takes at least 2 highs or 2 lows to be able to draw a valid trendline.

It takes at least 3 peaks or 3 troughs to validate it.

The more volatile the price, both up and down, the closer the trendline will approach verticality and the less reliable it will be.

It is essential to specify that on a time interval of 1 hour, you can find a bullish phase, and on a time interval of 1 day, you can find a bearish phase.

This indicator is therefore used to set price targets. The advantage of this tool is that it allows you to set goals over a short and long period.

When we understand market cycles and master the use of indicators, we can help people make the right investment decisions for themselves. Bitcoin rainbow charts can be a great tool for anyone to identify reasonable buy and sell areas. However, we still need to use other indicators and sources of information to combine and make judgments.

More By This Author:

What Is The Ethereum Rainbow Chart And How Does It Work?
Explanation of Myths Regarding The Ethereum Merge
Bitcoin And Ethereum: The Price Is In A Bad Condition Again

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