What is Bitcoin Rainbow Chart?

Foreword

When exploring Bitcoin price trends, many investors often find themselves overwhelmed by traditional technical analysis charts—these charts are typically filled with complex technical indicators and specialized terminology, making it difficult for ordinary investors to intuitively assess Bitcoin’s market trends. In some cases, the overload of information may even cause them to miss critical buying and selling opportunities. In response to these challenges, the Bitcoin Rainbow Chart was introduced.

The Bitcoin Rainbow Chart is an innovative visual analysis tool that eliminates the complexity of traditional financial charts. Instead of relying on intricate technical indicators, it utilizes a series of rainbow-colored bands, ranging from blue to red, to help investors intuitively identify Bitcoin’s valuation range. This allows investors to determine whether the market is undervalued, fairly valued, or in a bubble phase. Without the need for an in-depth understanding of concepts such as candlestick patterns or moving averages, investors can quickly obtain reference information on market trends.

Bitcoin rainbow chart (Image source:https://blocktrade.com/bitcoin-rainbow-chart/）

What is the Bitcoin Rainbow Chart?

The Bitcoin Rainbow Chart is a unique visual analysis tool that intuitively presents Bitcoin’s long-term valuation range through color layering. This concept was first introduced in 2014 by BitcoinTalk forum user Trolololo. Its core methodology is based on modeling Bitcoin’s historical closing prices and applying logarithmic regression to calculate the distribution of various price ranges, which are then visually represented using different color bands to indicate market trends.

The greatest advantage of the Rainbow Chart lies in its ability to simplify complex data analysis, allowing investors to more intuitively understand Bitcoin’s long-term trends and clearly identify the market phase of the current price. By incorporating color coding, the Rainbow Chart provides a convenient method for investors to assess whether Bitcoin is undervalued or has entered an overheated market phase, thereby optimizing buy and sell decisions and enhancing the effectiveness of investment strategies.

Bitcoin rainbow chart example (Image source:https://www.tradingview.com/script/hifY3Gu9-Bitcoin-Rainbow-Logarithmic-Curves/)

Color Band Interpretation and Operation Logic

Bitcoin’s rainbow chart is built based on a logarithmic regression model, dividing price trends into different color levels. The definitions of each color band are as follows:

Blue range (dark blue → light blue):

The price is in a severe undervaluation phase, which usually corresponds to a period of heavy market panic. This stage is considered the best buying opportunity for long-term investors and has historically appeared multiple times at the bottom of bear markets.

Green range (dark green → light green):

Indicates that the price of Bitcoin is in a reasonable valuation range, the market sentiment is stable, suitable for holding and waiting, waiting for further confirmation of the market trend.

Warm colors (yellow → red):

Representing the market entering the overvalued to bubble risk zone, indicating excessive market sentiment, a large influx of speculative funds, prices may be at a local high point or bubble stage. In addition, this area often coincides with the peak of a bull market, investors need to be alert to the price correction risk brought by the overheated market.

Bitcoin rainbow chart color band interpretation (Image source: https://blocktrade.com/bitcoin-rainbow-chart/）

The main function of the rainbow chart

1. Market sentiment judgment

The Rainbow Chart intuitively presents Bitcoin’s market sentiment through color bands, enabling investors to quickly determine whether the market is in a state of fear or greed. When Bitcoin’s price enters the red or orange zones, it typically indicates an overvalued market with a potential bubble risk. Conversely, when the price falls within the blue or green zones, it may suggest that the market is in an undervalued phase, presenting potential buying opportunities for long-term investors.

2. Filter Market Noise

In Bitcoin’s highly volatile market, daily price fluctuations often disrupt investors’ judgment, leading to emotionally driven trading. The Rainbow Chart helps mitigate this volatility by emphasizing macro trends and reducing the interference of daily price movements. For investors using the dollar-cost averaging (DCA) strategy for long-term positioning, the Rainbow Chart provides a more intuitive way to determine whether the market is within a reasonable long-term holding range.

3. Auxiliary Investment Strategies

The Rainbow Chart not only helps investors identify market turning points but also serves as a reference for different investment strategies. For example, when the price enters the red zone, investors may consider partially taking profits to mitigate the risk of a market correction caused by overheating, allowing for more rational decision-making.

Limitation Notice

First, the rainbow chart is built on historical data, relying on Bitcoin’s past price trends to speculate on future prices. However, like all historical analysis methods, past trends do not guarantee future repetitions, and Bitcoin’s dynamics are easily influenced by various factors, such as regulatory policy changes, technological advancements, investor sentiment, etc., each of which could quickly alter market structure and render the rainbow chart predictions ineffective.

In addition, excessive reliance on the rainbow chart may lead to certain information loss, ignoring other key technical signals, such as the relative strength index, MVRV, NUPL, and other on-chain data. For example, when the rainbow chart shows Bitcoin is in the ‘undervalued’ range, if the RSI simultaneously shows overbought signals, it may mean that there is still downward risk in the short-term price. Therefore, the rainbow chart is not suitable as a precise guide for short-term trading decisions.

Conclusion

The Bitcoin rainbow chart has always been an important reference tool for investors to evaluate market sentiment due to its intuitive visual presentation and analysis capabilities of long-term trends. It is recommended that investors combine on-chain data, technical indicators, and macroeconomic factors for comprehensive analysis when using the rainbow chart, in order to more comprehensively grasp market trends and avoid disturbances caused by short-term fluctuations. After all, rational investment decisions should be based on multidimensional market analysis, and any single technical indicator can only serve as a supplementary tool, unable to fully reflect the overall market situation. Only by mastering more information can more rational decisions be made.