If you’re interested in cryptocurrency investing and have spent any time perusing crypto Twitter in 2022, you have most likely seen those colorful bitcoin rainbow charts. This short guide to the bitcoin rainbow charts will explain what they are and why they’re useful. But first here’s some background on bitcoin and crypto that will put this investor recommendation tool in context.
Table of Contents
What Is Bitcoin And Why Are Cryptocurrencies Such A Big Deal?
Bitcoin is an alternative currency to fiat money like the US dollar. It’s a cash savings and payment system. What makes it unique is that it is not operated by an institution like a government or bank. Bitcoin is run on a decentralized, peer-to-peer (P2P) network.
Participants join the network to maintain it (for a reward) or use it without needing to ask anyone’s permission. Participants are also all anonymous to each other. These are all revolutionary innovations in banking and cash services.
The deflationary aspect of bitcoin is too. The network will only ever issue a maximum supply of 21 million bitcoin. These features and benefits made it so popular in the first place and launched the cryptocurrency class of digital assets.
Why Is Bitcoin’s Price So Volatile And Unpredictable?
Bitcoin and other cryptocurrencies are notorious for having a volatile and unpredictable price on liquid exchange markets. That’s because these are novel and highly sought after technologies and digital services for financial products. It’s similar to the way high growth tech stocks in the NASDAQ Composite have volatile prices along with their rapid growth in value.
Another reason that makes Bitcon and cryptos especially volatile on top of their rapid growth is the extreme liquidity that goes along with decentralized digital assets. Stock trades take some time to execute, going from investor, to broker, to order flow in liquid pools, and so on.
With the decentralized nature of Bitcoin, developers have built exchange infrastructure that moves it around very fast. While it can take hours or days to trade stocks, cryptos can change hands many times in one day. That makes for a bumpy ride for crypto investors.
Day traders love this volatility, because their business is based on trading against volatility. Their activity in these markets increases the wild price swings all the more.
What Can Be Predicted About The Bitcoin Price?
Nothing About The Future Of Anything Can Be Predicted With Absolute Certainty.
There are, however, ways to make educated guesses about what the Bitcoin price may do over a certain future timeframe. They involve understanding the industry and markets, and the determinants of supply and demand for cryptos like Bitcoin.
For example, when halving events occur (every four years, Bitcoin decreases its miners’ reward by half), the price tends to increase, all other things being equal. That’s because there’s a consequent decrease in the new supply of bitcoin. Making bitcoin more scarce, this increases its market value against currencies like the dollar that feature an increasing supply.
Also, when the market for bitcoin becomes overheated, participants begin to sell to scoop profits, while others stop buying because the price is too high for them. This is where bitcoin rainbow charts come in…
What Are Bitcoin Rainbow Charts?
Bitcoin rainbow charts are a static recommendation tool based on back testing buy, hold, and sell strategies over the historical price movements of bitcoin on crypto exchanges. They feature a band of recommendations that cover the crypto’s price movements on a historical time scale.
So when the price gets into the red and orange zone, the chart says it’s time to sell. When the price goes into the blue and violet zone, historically it was a good time to buy to maximize profits when the investor does sell. The color coded legend for the chart is in the easily memorable ROY G BIV colors of the rainbow. That’s how it got its name.
Are Bitcoin Rainbow Charts Reliable?
So the question is, are bitcoin rainbow charts reliable? Yes and no. The standard maxim of all professional investing is that past results do not guarantee future performance. But there is useful predictive power behind enough historical data viewed correctly.
These charts can’t give you a fool proof trading strategy. What they can do is show you when you would have done well to buy, hold, or sell in historical markets. Investors can use that information to make smarter decisions as part of an informed strategy for the current market.
Advantages And Disadvantages Of The Bitcoin Rainbow Charts
The disadvantage of bitcoin rainbow charts is that they make static recommendations. They do not adjust based on current market data, industry news, or prevailing macro headwinds and tailwinds. That’s information you’ll have to keep staying up to date on using sources outside these charts.
The advantage of them is they are simple, conservative, and take the guesswork out of when to buy, sell, or hold bitcoin. That way investors can check their emotions at the door and let the chart do the steering for them to keep their holdings profitable.