What is Ethereum Rainbow Chart and how do you read one?

If you are interested in investing in crypto, you have probably heard about the Rainbow Chart, which is a visual tool for making informed investment decisions based on the asset’s behavior in the previous market cycles. Although the first crypto rainbow chart was created for Bitcoin, a replica of it was later applied to track the historical performance of Ethereum, the second-largest cryptocurrency by market capitalization after Bitcoin. 

The following guide takes you on a quick tour of using the Ethereum Rainbow Chart to spot the right time for entry and exit, maximizing profits from your investment in ETH. 

What is Ethereum Rainbow Chart?

The Ethereum Rainbow Chart is a visualization tool that plots the price history of Ethereum over time on a logarithmic scale and uses nine distinct color bands — hence the name rainbow — to indicate when it may be the best time to sell, buy, or HODL. 

On Ethereum Rainbow Chart, red and orange hues typically signal an overbought zone, while greens and blues indicate that ETH is undervalued. However, it's worth mentioning that its accuracy and usefulness as a predictive tool for future price movements are a matter of debate among cryptocurrency analysts and traders. For instance, Bitcoin Rainbow Chart from 2014-2022 is apparently dead now, as the 2022 bear market proved too strong, and the price slipped below the last blue band. However, the crypto community's love for rainbows is undefeatable, so BTC enthusiasts simply adjusted the logarithmic growth curve to fit the new data and called it Bitcoin Rainbow Chart V2.

Who created the ETH Rainbow Chart?

In 2014, an anonymous Reddit user azop was the first to use colorful bands to show the Bitcoin historical price patterns, and later that year, a BitcoinTalk user named trolololo came up with an idea to use logarithmic regression to forecast future BTC price. The final touch to the model was added by a Bitcoin enthusiast Uber Holger, who added captions and interpretations to each band. Holger was also the one to apply it to the ETH price, thus giving birth to the Ethereum Rainbow Chart.

What is the difference between the Bitcoin and Ethereum Rainbow Charts?

The Ethereum Rainbow Chart and the Bitcoin Rainbow Chart are different in terms of the price ranges they represent, which makes sense, as Ethereum has historically been less valuable than Bitcoin. However, the most significant difference between the Bitcoin and Ethereum Rainbow Charts is the time frame. While the Bitcoin price history used in the chart dates back to 2010, Ethereum's historical price performance only goes back to 2015, which makes it much less reliable.

Additionally, Bitcoin Rainbow Chart suggests possible price levels up to 2023, while that of Ethereum trends only for a couple of months in the future — until October 2023 at the time of writing.

Read also: Fundamental analysis in crypto: should it be in your toolbox?

Both charts may be useful for visualizing the historical price trends of their respective cryptocurrencies, and can help investors identify potential support and resistance levels based on past price movements. However, it's important to note that these charts should not be the sole basis for making investment decisions.

How to Interpret the Ethereum Rainbow Chart

As already mentioned, Ethereum Rainbow Chart uses nine bands of different colors, each corresponding to a particular Ethereum price level and market sentiment. So, what exactly each one of them stands for?

Magenta = Maximum Bubble Territory

The magenta color suggests that the market is in a bubble that may burst very soon. At this point, the price of ETH is significantly overvalued, so investors may consider selling at a profit and then buy ETH back when it goes drops in value.

Orange = Go back to BTC?

The orange zone represents a market phase where investors consider selling their ETH for Bitcoin in expectation that the market will soon experience a massive correction. Not a bubble yet, but extremely close to it.

Light Orange = But have we 'earned' it?

The light orange zone suggests that Ether's price is rising at an unsustainable rate, and more investors are likely to ape into ETH because of FOMO. At this point, those who bought ETH at lower prices and recorded some paper gains are tempted to sell and lock in profits, hence the caption.

Yellow = Is this The Flippening?

The yellow zone represents a market phase when ETH enters speculative territory. At this point, the crowd of investors starts cheering on the long-awaited "flippening," which refers to a hypothetical event when Ethereum overtakes Bitcoin in terms of market.

Yellow-Green = Altseason

The yellow-green band signals a brief period when altcoins outperform Ethereum, rapidly appreciating in price while ETH dominance decreases. Investors confident in Ethereum's long-term growth may choose to hold onto their coins instead of cashing out and pouring money into alts.

Green = Still cheap

At this point, the ETH price is showing signs of an upward trend, but still represents an attractive buying opportunity for long-term holders. This is the time when the bull market millionaires are made.

Green-Blue = Accumulate

The green-blue zone indicates ETH is trading at its fair value, so bullish investors may go on a buying spree and purchase more coins to add to their stash. At this point, Ether is in its stable phase and may soon enter the growth territory.

Light Blue = Undervalued

This zone represents a slight recovery from the market bottom. It can be the first sign of a trend reversal, as well as a bull trap, so investors are advised to exercise caution when dealing in such an environment.

Blue = Fire Sale

The blue color on the Ethereum Rainbow Chart represents a significant dip or correction, and the price of ETH is relatively low compared to historical data. It may be a rare chance to buy Ether at a discount, but it's also crucial to investigate what caused the crash in the first place.

Limitations and Risks of Using the Ethereum Rainbow Chart for Investing

It's important to keep in mind that the Ethereum Rainbow Chart is not an exact science and shouldn't be relied upon to make investment decisions. Sure, it remained relatively accurate since 2016, but it was never intended to be predictive — rather, it was meant as a humorous and entertaining model. The golden rule of investing is that past performance does not guarantee future results, so expecting an asset to follow the trajectory of its historical movement is nothing but folly.

To make extra sure that I correctly interpret Rainbow Chart as a community-driven meme and coping strategy, I reached for comment from Jakub Derlukiewicz, a research analyst at Student Coin, whose daily work involves examining market trends and evaluating crypto assets.

"The Ethereum Rainbow Chart cannot predict the price of ETH. It can be only helpful to assess how fast it can hit a certain price range based on the room for growth left, but otherwise, it's just a metric promoted by get-rich-quick wannabes. What it really shows is that crypto markets aren't fully liquid yet, and with relatively small capital inflows the price of an asset can increase significantly, rallying 10x or even 100x. However, just like the real rainbow touches the ground somewhere, the chart also won't grow infinitely — but those selling the dream of getting rich from crypto won't include this part in their estimates," was the candid response from Derlukiewicz.

Uber Holger, the inventor of the chart, also warned the crypto community against taking his creation as investment advice, saying that it was only meant to be a fun way of looking at the historical price performance of an asset. In his own words:

"Rainbow Charts can’t predict the price of cryptocurrencies. Unlike the Bitcoin Rainbow Chart which at least goes back to 2014, I literally just tweaked the formula for the chart until it fits reasonable well to the price development. This is not investment advice! I am just responding to popular requests to make an 'Ethereum Rainbow Chart' because people (and the Ethereum Community in particular) love rainbows."