Key points
The Bitcoin Rainbow Chart is a graphical tool that can indicate whether Bitcoin (BTC) is undervalued, overvalued, or fairly valued, based on its historical prices.
It consists of a series of colored bands that represent different price ranges. The position of the price within the colored bands can provide insights into market sentiment and possible long-term movements.
The BTC Rainbow Chart was created as a meme in 2014, with the addition of colors to a logarithmic scale chart. The formula was changed in 2019, giving rise to the second version of the chart, Bitcoin Rainbow Chart V2.
The accuracy of the Bitcoin Rainbow Chart remains a topic of discussion due to its heavy reliance on historical data and subjective parameters.
What is BTC Rainbow Chart?
The Bitcoin Rainbow Chart is a technical analysis tool used to track the performance of Bitcoin (BTC). The Rainbow Chart uses a series of colored bands that can indicate different phases of market sentiment, suggesting whether Bitcoin is undervalued, overvalued, or fairly valued.
How was the Bitcoin Rainbow Chart created?
The first Bitcoin Rainbow Chart was created in 2014 by a Reddit user named “azop,” who designed it as a fun way to represent Bitcoin’s price history. At the time, the BTC Rainbow Chart didn’t have an arc. It was simply made up of straight colored bands on a logarithmic scale graph.
In 2019, Bitcoin user Rohmeo tweaked the formula to create the Bitcoin Rainbow Chart V2, which has an arc and uses a more scientific way of modeling prices. The new formula was inspired by a logarithmic regression chart created by BitcoinTalk user “trolololo” in 2014.
How to Use Bitcoin Rainbow Chart
Both the V1 and V2 versions of the BTC Rainbow Chart are available on Rohmeo’s website, BlockchainCenter. While there is no guarantee that the rainbow chart model will be successful in the long run, it is still worth learning how to use.
1. Identify the current price range.
Start by identifying the price range that the BTC price is in. You can do this by zooming in on the most recent price action and hovering your mouse over the price line.
2. Interpret the color of the stripe.
Once you've identified the current price range, you can use the suggested color scheme to interpret its meaning.
According to the model, lower colors suggest potential oversold conditions, while higher colors suggest an overbought market. From bottom to top:
Dark Blue (“Basically a Fire Sale”): Extremely undervalued.
Cyan ("BUY!"): Highly undervalued.
Green ("Accumulate"): undervalued.
Light green ("Still cheap"): a little undervalued.
Yellow ("HODL!"): Fair value.
Orange ("Is this a bubble?"): may be overvalued.
Light red ("FOMO intensifies"): probably overvalued.
Red ("Sell. Seriously, SELL!"): Highly overvalued.
Dark red (“Maximum Bubble Territory”): extremely overvalued.
3. Consider the historical context.
Consider analyzing the historical price action within different color bands. Notice patterns and trends that emerge when the price of Bitcoin was in a similar range. For example, when BTC entered the dark blue band in the past, what happened next? Did the price generally move higher soon after, or was there sideways price action?
4. Combine with other indicators.
While the Bitcoin Rainbow Chart is an interesting tool for understanding market sentiment, it should be used alongside other strategies and indicators to reduce risk. Here are some additional tools to consider:
Trading Volume: Examine Bitcoin's trading volume to understand market activity. For example, high trading volume usually signals strong market interest.
Technical Analysis Indicators: Consider other technical analysis tools such as moving averages, Relative Strength Index (RSI) and Moving Average Convergence/Divergence (MACD) to identify trends and possible reversal points.
Macroeconomics: Consider the current macroeconomic outlook before taking financial risks. Are interest rates high or low? What about inflation and global liquidity? These questions can help you understand the outlook and assess whether investors are more inclined to risk or safety.
Does the Bitcoin Rainbow Chart work?
The accuracy of the Bitcoin Rainbow Chart is a topic of debate among investors and analysts. Here are some points to consider when evaluating its accuracy:
Historical basis
The Bitcoin Rainbow Chart is based on historical data, using past price movements to create a visual representation of market sentiment. This can provide valuable context and insight into Bitcoin’s past price behavior. However, the reliance on historical data means that the chart does not fully account for new developments in the cryptocurrency market.
Logarithmic regression
The Rainbow Chart uses logarithmic regression to smooth out Bitcoin’s volatility and create a more stable trendline. This helps illustrate long-term trends and potential price ranges, but it is not foolproof. The assumptions made when creating the regression line can affect its predictive power.
Subjectivity of color ranges
The color bands on the Bitcoin Rainbow Chart are determined subjectively. The definitions of “undervalued”, “fair value” or “overvalued” are not fixed and can vary depending on the size of each band or one’s interpretation.
It is worth noting that the purple band on the BTC Rainbow Chart V1 was added at a later stage because the previous model failed when the BTC price fell below the lower band.
Benefits of Bitcoin Rainbow Chart
The Bitcoin Rainbow Chart offers several advantages for cryptocurrency traders looking to optimize their trading strategies:
It provides a simplified visual representation of historical price movements and market sentiment.
It can help investors understand Bitcoin's long-term price action.
The color bands provide insight into potential buying, holding, and selling opportunities.
Limitations of Bitcoin Rainbow Chart
While the Bitcoin Rainbow Chart is a valuable tool for visualizing long-term market trends, it has several limitations that traders should consider:
It relies heavily on historical data and does not take into account recent events or developments in the cryptocurrency market.
The number of bands, colors and other parameters are subjective, which can lead to different results and conclusions.
Are there other crypto charts that use the rainbow model?
While the Bitcoin Rainbow Chart remains the most well-known rainbow chart model, the concept has also been adapted for Ethereum. Similar to the Bitcoin Rainbow Chart, the Ethereum Rainbow Chart uses colored bands to illustrate Ethereum’s price history.
Final considerations
The Bitcoin Rainbow Chart is a tool that helps visualize Bitcoin’s historical price action and market sentiment. Investors can use the Bitcoin Rainbow Chart to identify potential buying, holding, or selling opportunities. However, it is important to combine it with other indicators to reduce risk and increase the chances of success.
Further reading
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