Bitcoin enthusiasts have developed a wide range of indicators and models to predict future prices. In this article, we take a look at one of the favourites: the rainbow chart.
While the majority of volumes in the crypto markets is generated by short-term speculators, a large group of people HODLs cryptocurrencies for the long run. They try to buy Bitcoin towards the end of a bear market, and hold it for extended periods of time, ideally towards the end of the bull market.
Timing these entries and exits is difficult, but not impossible. Many traders have attempted to make this easier, by creating different indicators and models to predict future prices, or to help you put the price of Bitcoin in perspective. The Bitcoin Rainbow Chart is exactly that, a tool developed to understand the price of Bitcoin, relative to its behaviour in the previous market cycles.
The rainbow chart can help traders ignore the daily volatility, and view Bitcoin in the grander scheme of things. Moreover, users can derive different insights from the chart, but the biggest takeaway from the rainbow chart can be found in the name: the rainbow. This rainbow was developed as a fun, instructive way to help make buying and selling decisions, with each colour of the rainbow having a designated instruction on whether to buy, sell, or hold.
History of Bitcoin’s Rainbow Chart
The original Bitcoin Rainbow Chart was much different from the current one. This first version was developed by reddit user Azop merely to display Bitcoin’s price history in a funny way. While it was accurate as a decision-making tool for a while, it didn’t take long before a BitcoinTalk user Trolololo coined version 2.0 – pairing the rainbow chart with logarithmic regression.
Logarithmic regression is essentially the opposite of exponential growth. It’s used in a wide range of applications, from showing the growth of young children to this application: plotting Bitcoin prices. Rather than acceleration upwards, logarithmic growth decelerates over time. This makes sense in Bitcoin context, as it takes an increasing amount of capital to push Bitcoin higher – resulting in diminishing returns.
By pairing the Bitcoin rainbow chart with logarithmic growth, the model was usable in both the present, and the future too. To this day, the model recalibrates based on new price information, which means it will only become more accurate over time.
The Rainbow Chart, Old (left) vs New (right)
How To Use the Bitcoin Rainbow Chart in Your Trading?
As discussed, the rainbow chart has different colours, all paired with specific suggestions on trading decisions you can make when price reaches these coloured regions. Here are all the colours of the rainbow chart and what they mean, according to the model:
Red: Sell. When prices reach the red regions in the chart (red: Sell. Seriously, SELL! And dark red: Maximum bubble territory), the model strongly suggests users to take risk off, as prices are unreasonably high. While the chart doesn’t show it, the Red region technically has no maximum value. The sky, literally, is the limit.
Orange: Okay, this is a bull market. There are two orange regions on the chart, named “Is this a bubble?” and “FOMO intensifies”. These regions can signal the first take profit areas for conservative investors, while the more aggressive players see it as a signal that FOMO-fuelled rallies are coming soon – hence the name FOMO Intensifies.
Yellow: Hold! This region is where investors are best off sitting on their hands. Prices are not cheap enough to add to your holdings, and not as expensive enough to start taking profits. In essence, the yellow region is telling you to wait until higher prices.
Green: Keep buying! When price moves back up, out of the blue regions of the chart, we enter the green (accumulate) and light green (still cheap) bands. This is typically the region where many people end up buying, because the blue regions can get pretty scary. The green regions are a perfect time to get in when it is still early, while not feeling nearly as risky as buying in the blue region.
Blue: Buy Bitcoin.The lowest regions on the rainbow chart (navy blue: Basically a fire sale, and blue: BUY!) represent cheap prices. When price trades into these areas, many Bitcoin enthusiasts add to their Bitcoin holdings. In the past, buying Bitcoin in the blue zone has been an excellent decision. In a few months, we’ll know if this works out well once again. As with the red zone, the blue band – while the chart doesn’t show it – has no lower limit. Prices can continue to fall after reaching the blue region.
The rainbow chart is one of those indicators that has worked well since its inception. Historically, the red and blue regions have been turning points for Bitcoin. As always, the rainbow chart is not an exact science and we do not recommend anyone to make trading decisions based on the rainbow chart. Rather, it is an interesting way to look at Bitcoin prices – one that can be particularly useful in combination with other indicators and further analysis.
Closing Thoughts
All in all, the bitcoin rainbow chart is a simple way to view Bitcoin prices, and can definitely help in your decision making process. As always, it is important to remember that trading indicators are not an exact science, and historical accuracy does not necessarily imply accuracy in the future. The same is true for the rainbow chart, and we do not recommend anyone to make trading decisions based on the rainbow chart.
Nevertheless, the rainbow chart can be particularly useful in combination with other indicators and further analysis. Tools like the stock-to-flow model and the fear & greed index are very complementary to the rainbow chart, but we recommend using your own analysis (whether fundamental or technical) as well.
We wish you best of luck navigating the coming months, and happy trading!
Writer’s Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form. Please do your own research.
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