Key TakeawaysπŸ”‘

β†’The rainbow pattern is a trading strategy that uses multiple exponential moving averages with different periods.
β†’Using a rainbow pattern can help traders identify potential market trends and entry points.
β†’Like all trading strategies, the rainbow strategy has its limitations and should be combined with other analysis techniques.

Introduction

Today will not be about weather or sky-watching, although the rainbow pattern in the article title might presage such a discussion. Instead, we will talk about the non-standard use of moving averages to get a clear picture of the market and obtain valuable trading signals.

What is a rainbow pattern?

This graphical pattern includes use of three exponential moving averages with different periods. First with the period of six of blue color, second with the period of 14 of yellow color and third with the period of 26 of red color.

We propose to use the expotential average. It is also possible to use a simple moving average or any other you feel comfortable with. The basis of the rainbow pattern is not the type of average, but the use of several averages of different periods.

EMA's settings for rainbow pattern
EMA's settings for rainbow pattern

These 3 averages are enough for us. I think it's not hard to imagine that you can add more of them in different colours to make the image even more rainbow-like.

Often in studies on the rainbow pattern, we can find a recommendation that the averages should be with periods from 6 to 26 in intervals of 2. This would mean drawing as many as ten averages on the chart.

We like simple things, hence we have 3 averages, as they are the quintessence of this pattern.

Trading signals based on rainbow pattern

Chart with 3 moving averages
Chart with 3 moving averages

Many participants believe that there exist the following powerful signals of asset price decline. The blue line with the period of six is above all others. The yellow line with a period of 14 is under the blue line.

Red line with a period of 26 is below all others. The intersection of the blue line with the period of six and the yellow line with the period of 14 is for most traders the point of access to the market and purchasing the option.

Price movement after intersection (down)
Price movement after intersection (down)

The probability of price increase is higher, if the blue line with a period of six is below all others, and the yellow line with a period of 14 is above the blue line. Red line with the period of twenty-six is above all others.

The intersection of the blue line with a period of six and the yellow line with a period of 14 is for most traders. The point of access onto the market and of purchasing the option.

Price movement after intersection (up)
Price movement after intersection (up)

In addition to the signals we have listed, these several moving averages plotted on the chart have additional values. Take a close look at your charts and look at the relationship of the averages in different situations.

Notice what happens to a bunch of averages when the market is in a strong trend. You can see that the averages are strongly diverging from each other. In a consolidation of the trend they move closer together or even cross each other.

Remember, moving averages are not perfect. Mainly because they belong to the group of so-called lagging indicators.
This means that they are calculated directly from the historical prices of an asset and their reaction is delayed relative to the price.

They cannot show the future in any way. However, this in itself does not exclude their use as a signal generator in the form we have proposed today. We also encourage you to check our article about SMA strategy.

Pros and Cons of the Rainbow Pattern πŸ˜ŠπŸ™

Pros:

  • πŸ“ˆ Provides a visual representation of potential market trends
  • πŸ” Can be customized with different moving average periods and types
  • 🧩 Combines well with other technical analysis techniques

Cons:

  • 🐌 Lagging indicator, may not accurately predict future price movements
  • πŸ“Š Overuse of multiple moving averages can clutter charts and complicate analysis
  • 🚫 No trading strategy guarantees success; always perform your own research



Popular Moving Average Periods Common Usage
6-period EMA Short-term trend analysis
14-period EMA Intermediate trend analysis
26-period EMA Long-term trend analysis

Short Q&A: Frequently Asked Questions about Rainbow Pattern

How do I set up the rainbow pattern on my chart?

To set up the rainbow pattern, add three exponential moving averages (EMA) with periods of 6, 14, and 26. You can customize the colors for better visualization.

Can I use simple moving averages (SMA) instead of exponential moving averages for the rainbow pattern?

Yes, you can use simple moving averages or any other type of moving average you prefer. The essence of the rainbow pattern lies in the use of multiple moving averages with different periods.

How do I interpret the intersections of the moving averages?

When the shortest period moving average (6) crosses the intermediate moving average (14), it may signal a potential entry point. However, always perform additional analysis before making any trading decisions.

Are there any limitations to using the rainbow pattern?

The rainbow pattern is a lagging indicator, which means it is based on historical price data and may not accurately predict future price movements. Always use the rainbow pattern in conjunction with other technical analysis techniques.

Can I use the rainbow pattern for all types of assets and timeframes?

The rainbow pattern can be used for various asset classes and timeframes. However, its effectiveness may vary depending on the specific market conditions and the chosen asset. Always test your strategy on different assets and timeframes to find the best fit for your trading style.

Do you have any experience with rainbow patterns? Describe them in the comments below.

We wish you successful trading with IQ option.

GENERAL RISK WARNING

The financial products offered by the company carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.
Kindly note that this article does not provide any investment advice. The information presented regarding past events or potential future developments is solely an opinion and cannot be guaranteed as factual, including the provided examples. We caution readers accordingly.

How useful was this post?

Click on a star to rate it!

Average rating 4.6 / 5. Vote count: 34

No votes so far! Be the first to rate this post.

As you found this post useful...

Follow us on social media!

We are sorry that this post was not useful for you!

Let us improve this post!

Tell us how we can improve this post?


Bart Bregman

Author / IQ Option expert: "My name is Bart Bregman, I have 9 years of full-time professional trading experience. I've been trading with IQ Option for more than 7 years, mainly on the shorter time frames doing technical analyses, and have many experience with Binary Options, CFDs, Options, and Crypto trading. There is no such thing as a bad trade! As a digital nomad trader, I'm mostly traveling all over the world. Follow my journey on Instagram at https://www.instagram.com/bart_bregman/. "

Leave a Reply

Your email address will not be published.

20 − eighteen =