Rainbow Charts

Overview

The Rainbow Charts and Rainbow Oscillator indicators were created by Mel Widner, Ph.D. and originally introduced in the July 1997 issue of Stocks and Commodities magazine.

The Rainbow Charts indicators is trend-following indicator. The basis of the Rainbow Charts indicator is a 2-period simple moving average. Recursive smoothing is then applied to the original moving average thereby creating 9 additional moving averages; Each new moving average is based on the previous moving average. Through this use of recursive smoothing a full spectrum of trends is created that, when plotted using continuous colors, have the appearance of a rainbow.

The Rainbow Oscillator is also a trend-following indicator that is based on the same calculations used to create the Rainbow Charts. The Rainbow Oscillator is derived from a consensus of the Rainbow Charts trends. It defines the highest high and lowest low of those moving averages to create an oscillator and bandwidth lines based on those calculations.

Interpretation

One simple interpretation of the Rainbow Charts indicator is:

When the market is rising and the trend is up, the least smoothed line is at the top of the Rainbow (the red line) and the most smoothed line is at the bottom of the Rainbow (the violet line). When the market is declining and the trend is down the order of the Rainbow is reversed; the most smoothed line is at the bottom and the least smoothed line is at the top.

As the underlying market price moves up or down, the moving averages follow and cross in sequence as the move continues. Price moves away from the Rainbow are seen as potential trend continuations leading to a greater Rainbow width, while price moves towards (or into) the Rainbow are seen as potential reversals leading to a contraction of the Rainbow width. The depth that price penetrates into the Rainbow can be used to judge the strength of the move.

Implementation

The Price, Periods, and MA Type inputs of the initial trend line (moving average) have been parameterized to allow the user full customization of the Rainbow Charts indicator. The Rainbow Oscillator also allows the user to adjust the Oscillator Periods for further customization of that indicator. However, in both indicators the recursive smoothing for the additional trend lines (moving averages) remains as a 2-period simple moving average of the previous moving average.

© Help for New Traders