Key points to remember
The Bitcoin Rainbow Chart is a graphical tool that can indicate whether bitcoin (BTC) is undervalued, fairly valued, or overvalued 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 information about market sentiment and potential long-term movements.
The BTC rainbow chart was created as a meme in 2014 by adding colors to a logarithmic scale chart. The formula was modified in 2019, giving rise to the Bitcoin rainbow chart V2.
The accuracy of Bitcoin's rainbow chart remains a topic of debate due to its heavy reliance on historical data and subjective parameters.
What is the 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, fairly valued, or overvalued.
How was Bitcoin's rainbow chart created?
The first Bitcoin rainbow chart was created in 2014 by a Reddit user named âazop,â who designed it as a fun way to depict Bitcoinâs price history. At the time, the BTC rainbow chart wasnât actually shaped like a rainbow. It was simply a collection of colored stripes in a straight line on a logarithmic scale chart.
In 2019, Bitcoin user Rohmeo modified the formula to create the Bitcoin Rainbow Chart V2, which features an arc and uses a more scientific way of modeling price action. The new formula was inspired by a logarithmic regression chart created by BitcoinTalk user âtrolololoâ in 2014.
How to use Bitcoin's rainbow chart?
The V1 and V2 versions of the Bitcoin Rainbow Chart are available on Rohmeoâs website, BlockchainCenter. While there is no guarantee that the Rainbow Chart pattern will be successful in the long run, it is still worth learning how to use it.
1. Identify the current price range
Start by identifying the price range where the BTC price is located. To do this, zoom in on the most recent price movement and place your cursor on the price line.
2. Interpret the color of the band
Once you have 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 (âBasically a Fire Saleâ): Extremely undervalued.
Cyan (âBuy!â): greatly undervalued.
Green (âAccumulateâ or in French âAccumulezâ): undervalued.
Light green (âStill Cheapâ or in French âEncore bon marchĂ©â): slightly undervalued.
Yellow (âHODL!â or in French âHODLez!â): correctly evaluated.
Orange (âIs this a bubble?â): Perhaps overrated.
Light red (âFOMO intensifiesâ or in French âFOMO intensifiesâ): probably overrated.
Red (âSell. Seriously, SELL!â): Heavily overvalued.
Dark Red (âMaximum Bubble Territoryâ or in French âMaximum Bubble Zoneâ): Extremely overvalued.
3. Consider the historical context
Consider looking at the history of price movements in different color bands. Notice patterns and trends that emerge when Bitcoinâs price has been in a similar band before. For example, when BTC has entered the âDark Blueâ band in the past, what happened next? Did the price typically move higher shortly afterward, or was there sideways action in price movements?
4. Combine this indicator with others
While the Bitcoin rainbow chart can be an interesting tool to understand market sentiment, it should be used alongside other strategies and indicators to mitigate risk. Here are some additional tools to consider:
Trading Volume: Look at Bitcoinâs trading volume to understand market activity. For example, high trading volume is often a sign of strong market interest.
Technical Analysis Indicators: Consider other TA tools, such as Moving Averages, Relative Strength Index (RSI), and Moving Average Convergence Divergence (MCD), to identify trends and potential reversal points.
Macroeconomics: Consider the current macroeconomic scenario before taking a financial risk. What are the interest rates? What about inflation and global liquidity? These questions can help you understand the big picture and determine whether investors are more risk-averse or not.
Does Bitcoin's Rainbow Chart Work?
The accuracy of Bitcoinâs rainbow chart is a topic of debate among investors and analysts. Here are several points to consider when assessing its accuracy:
Historical background
Bitcoinâs rainbow chart is based on historical data and uses past price movements to create a visual representation of market sentiment. This can provide valuable context and insight into how bitcoinâs price is behaving. However, the reliance on historical data means that the chart may not fully account for new developments in the crypto market.
Logarithmic regression
The rainbow chart uses logarithmic regression to smooth out Bitcoinâs volatility and create a more stable trendline. This helps illustrate long-term trends and potential price ranges, but itâs not foolproof. Assumptions made when creating the regression line can affect its predictive power.
The subjectivity of color bands
The colored bands in Bitcoin's rainbow chart are determined subjectively. The definitions of "undervalued", "correctly valued", or "overvalued" are not fixed and can vary depending on the size of each band or who is interpreting the chart.
It is worth noting that the purple band of the BTC V1 rainbow chart was added later, as the previous pattern failed when BTC price fell below the lower band.
Advantages of Bitcoin Rainbow Chart
Bitcoin's rainbow chart offers several benefits to cryptocurrency traders looking to optimize their trading strategies:
It provides a simple visual representation of historical price movements and market sentiment.
It can help investors understand the long-term evolution of bitcoin price movements.
Color bands can provide indications of potential buying, holding, and selling opportunities.
Limitations of Bitcoin's Rainbow Chart
While the Bitcoin rainbow chart is a valuable tool for visualizing long-term market trends, it has several limitations that traders should be aware of:
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 any other rainbow crypto charts?
While Bitcoinâs rainbow chart remains the most well-known rainbow chart, the concept has also been adapted for Ethereumâs Ether. Similar to Bitcoinâs rainbow chart, Ethereumâs rainbow chart applies colored bands to Etherâs price history.
Conclusion
The Bitcoin Rainbow Chart is a tool that helps visualize the historical evolution of Bitcoin price movements and market sentiment. Investors can use the Bitcoin Rainbow Chart to identify potential opportunities to buy, hold, or sell. However, it is important to combine it with other indicators to mitigate risk and increase your chances of success.
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