Introduction to the Bitcoin Rainbow Chart: A Step-by-Step Guide

The Bitcoin Rainbow Chart is a popular tool in the world of cryptocurrency, used to check the performance of Bitcoin (BTC) over time. It provides a colorful visual representation of Bitcoin’s price history. It helps traders and investors determine whether the asset is undervalued, fairly valued, or overvalued. By using different colored bands, the chart attempts to reflect the overall sentiment of the market.

How Was the Bitcoin Rainbow Chart Created?

The Bitcoin Rainbow Chart was created by a Reddit user named “azop” in December 2014, and it was initially intended to be both entertaining and basic to demonstrate Bitcoin’s price action, with linear color bands on a logarithmic axis. It functioned as an efficient reference for traders to determine the status of the Bitcoin market.

Later in 2019, another Bitcoin fan going by the name Rohmeo updated the chart and what came as Bitcoin Rainbow Chart V2. This update added a bow-shaped curve and relied on scientific methods to estimate Bitcoin’s price more accurately. Rohmeo’s improvements were inspired by a logarithmic regression chart that was made by user of BitcoinTalk by the nick “trolololo” in 2014. This new version was designed to be more representational of the long-term tendencies of Bitcoin price.

How to Use the Bitcoin Rainbow Chart

The process of trading using the Bitcoin Rainbow Chart is quite easy, which makes it appropriate for use by both new and experienced traders. Here are the key steps to utilizing the chart effectively:

Identify the Current Price Band

To use the chart, one should first define the current price range in which the Bitcoin is currently trading. This can be achieved by focusing on the most recent price action and then moving the mouse over the price line on the chart. The color of the band in which this price lies will show the prevailing sentiment of the market at that point of time.

Interpret the Color Bands

The chart also employs color-coding whereby green represents highly undervalued markets and red means extremely overvalued markets.

 Here is what each color represents:

Dark Blue (Basically a Fire Sale)

Bitcoin is extremely undervalued, indicating a strong buying opportunity.

Cyan (BUY!)

Bitcoin is highly undervalued, suggesting it’s a good time to buy.

Green (Accumulate)

Bitcoin is undervalued, and investors might consider accumulating.

Light Green (Still cheap)

Bitcoin is somewhat undervalued, offering a decent buying opportunity.

Yellow (HODL!)

 Bitcoin is fairly valued, and holding might be the best strategy.

Orange (Is this a bubble?)

 Bitcoin may be overvalued, cautioning investors.

Light Red (FOMO intensifies)

Bitcoin is probably overvalued, signaling caution.

Red (Sell. Seriously, SELL!)

Bitcoin is highly overvalued, indicating it might be a good time to sell.

Dark Red (Maximum Bubble Territory)

Bitcoin is extremely overvalued, strongly suggesting a sell.

Consider Historical Context

It is also important to keep in mind the historical course within all the color stages when applying the indicator of the Bitcoin Rainbow Chart. To make better predictions about future returns, trends from the past can reveal how Bitcoin has behaved given the same conditions of the market.

Combine with Other Indicators

However, the Rainbow Chart for Bitcoins is an effective tool, but it should be used in conjunction with other indicators. It is beneficial to incorporate charting with other technical analysis tools and indicators to improve trading decisions and manage risks. Some useful additional tools include:

Trading Volume

 Big traded volume serves to support price change. It also ensures that any price changes in the market are market forces backed by volume.

Technical Analysis Indicators

 Some of these indicators include the moving average or trend-line, the relative Strength Index (RSI), the moving Average Convergence Divergence (MACD).

Macroeconomic Factors

To some extent, understanding of market environment such as interest rates, inflation rates and global liquidity can be helpful when determining potential risks that may exist in the context of the market environment.

Does the Bitcoin Rainbow Chart Work?

It is still up to debate whether the Bitcoin Rainbow Chart is a good trading tool or not among the traders and analysts. Completely accurate as it uses historical data, it can provide a prediction about the price trends in the future. For this reason, the chart may not capture all the modern trends that are developing within the scope of cryptocurrency.

Benefits of the Bitcoin Rainbow Chart

The Bitcoin Rainbow Chart offers several advantages for traders and investors:

Visual Representation

The chart used in this context is comprehensive and easily understandable, as it captures the entire price history of Bitcoin as well as the market sentiment.

Long-Term Perspective

However, TradingView allows investors to not only analyze Bitcoin’s price trends and its characteristics, but also the opportunities to buy, store, or sell.

Limitations of the Bitcoin Rainbow Chart

Despite its usefulness, the Bitcoin Rainbow Chart has limitations that traders should be aware of:

Reliance on Historical Data

 The chart is critically based on previous prices and does not capture other market dynamics that are relevant today.

Subjectivity

The use of color bands to denote a trend in price movement is somewhat arbitrary. This means that different people can come to different conclusions given the same information.

Conclusion

The Bitcoin Rainbow Chart is a novel way of looking at Bitcoins price trends and market sentiment in an easy-to-comprehend visual manner. This methodology allows traders and investors to determine in a timely manner when Bitcoin is undervalued, valued fairly or overvalued each hour by referring to the relevant color-coded bands. The chart started off as a fun, simple reference but with its V2 version it is now much more detailed and sophisticated.