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 stages of a market trend, indicating whether Bitcoin is undervalued, fairly valued, or overvalued.
How was the Bitcoin 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 visualize Bitcoinâs price history. At the time, the Bitcoin rainbow chart had no curve, and was simply made up of straight-line colored bands on a logarithmic scale chart.
In 2019, a Bitcoin user named âRohmeoâ changed the equation to create the second version of the Bitcoin rainbow chart, which features a curve and uses a more scientific method to display prices. The new equation was inspired by a logarithmic regression chart created by a Bitcoin user named âtrolololoâ in 2014.
How to Use the Bitcoin Rainbow Chart
Both the first and second 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 useful to learn how to use it.
1- Determine 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 movements and moving the cursor above the price line.
2- Explain what the color of the band means.
Once you have determined the current price range, you can use the suggested color scheme to interpret its meaning.
According to the pattern, the lower colors indicate potential oversold conditions, while the upper colors indicate overbought conditions in the market. From bottom to top:
Dark Blue (âNearly Burning Priceâ): Vastly undervalued.
Heavenly ("Buy!"): Much less than its true value.
Green ("Aggregate"): Undervalued.
Light green ("still cheap"): somewhat undervalued.
Yellow ("Keep!"): Fair value.
Orange (âIs this a bubble?â): You may be overdoing it.
Bright red (âfear of missing outâ): probably exaggerated.
Red (âSell! You really should sell!â): Too overpriced.
Dark red ("maximum bubble area"): Extremely overvalued.
3- Think about the historical context.
Consider looking at historical price movements within the different color bands. Notice patterns and trends that have emerged when Bitcoinâs price has been in a similar range in the past. For example, when Bitcoin has entered the âdark blueâ band in the past, what has happened next? Did the price typically rise shortly after, or were there occasional price movements?
4- Combine the chart with other indicators.
While the Bitcoin rainbow chart can be an interesting tool for understanding market trends, it should be used in conjunction with other strategies and indicators to mitigate risk. Here are some additional tools you can consider:
Trading Volume: Look at Bitcoin trading volume to understand market activity. For example, high trading volume often indicates strong interest in the market.
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 potential reversal points.
Macroeconomics: Study the current state of the macroeconomics before taking financial risks. How high or low are interest rates? What about inflation and global liquidity? These questions can help you understand the big picture and assess whether investors are more willing to take risks.
Is Bitcoin Rainbow Chart Successful?
The accuracy of the Bitcoin rainbow chart is a matter of debate among investors and analysts. Here are several points to consider when assessing its accuracy:
Historical basis
The Bitcoin rainbow chart is based on historical data, using past price movements to design a visual representation of market trends. This can provide valuable context and insights into Bitcoin price behavior. However, relying on historical data means that the chart may not fully explain new developments in the cryptocurrency market.
Logarithmic regression
The rainbow chart uses logarithmic regression to smooth out Bitcoinâs volatility and provide greater stability to the trendline. This helps illustrate long-term trends and potential price ranges, but it is not infallible. The assumptions made when constructing the regression line can affect its predictive power.
Subjective vision of colored bands
The colored bands in the Bitcoin rainbow chart are subjective. Definitions of terms such as âundervalued,â âfairly valued,â or âovervaluedâ 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 was added to the first version of the Bitcoin rainbow chart at a later stage because the previous pattern failed when the Bitcoin price fell below the lower band.
Advantages of Bitcoin Rainbow Chart
The Bitcoin Rainbow Chart offers several advantages to crypto traders looking to improve their trading strategies:
It provides a clear visual representation of historical price movements and market trends.
It can help investors understand Bitcoin price movements over the long term.
The colored bands can provide some guidance about potential buy, hold, and sell opportunities.
Bitcoin Rainbow Chart Shortcomings
While the Bitcoin rainbow chart is a valuable tool for visualizing long-term market trends, it has several shortcomings that traders should keep in mind, including:
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 variables are subjective, which may lead to different results and conclusions.
Are there any rainbow charts for other cryptocurrencies?
While the Bitcoin rainbow chart is still the most popular, this concept has also been applied to Ethereum. Similar to the Bitcoin rainbow chart, the Ethereum rainbow chart applies colored bands to Ethereumâs price history.
Closing thoughts
The Bitcoin rainbow chart is a tool that helps visualize historical Bitcoin price movements and market trends. 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.
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