The world of trading is full of surprises. Turns out, there is even an indicator that looks like a rainbow. Rainbow Moving Average is an interesting take on a simple moving average. Basically, it is 10 indicators in one (and could be even more if you wish so).
Why use 10 simple moving averages when you can use only one? The thing is, when several moving averages with different periods are used simultaneously, they can be used as an indicator of their own. Rainbow can be used on any time frame and asset. Here is one more reason to use it: Rainbow MA looks absolutely stunning when overlaid on the price chart.
Already interested? Read the full article to learn about this analysis tool and ways to apply it in trading.
How does it work?
Any moving average is a trend-following tool. Rainbow MA is a combination of moving averages of different length that are all plotted on the same price chart. Their intersection, therefore, can hint at a price reversal and help estimate the trend strength. Note that the more lines you deploy, the longer it takes for the indicator to demonstrate a ‘complete reversal’ (an intersection of all moving averages).
There are several ways to use Rainbow. First, it can be combined with other technical analysis tools as a trend-following indicator. In this case, when the trend is strong (as identified by Rainbow) and the indicator you use to determine entry points sends a bullish signal, traders consider opening a BUY position. When the trend is strong (as identified by Rainbow) and the indicator you use to determine entry points sends a bearish signal, traders consider opening a SELL position. When the trend is weak, traders would generally abstain from opening new positions.
Rainbow can also be used on its own. The angle of the moving averages will hint at the trend strength. The steeper the curve, the stronger the trend. The flatter the curve, the weaker the trend. Consider opening a BUY position in the very beginning of a strong positive trend, just as you could consider opening a SELL position in the beginning of a strong negative trend. A lot of traders find it useful to double-check the signals sent by Rainbow with other indicators, however.
There is one more way to apply Rainbow Moving Average. During a strong trend, traders look for a short-lived retracement (both can also be identified with this indicator) and enter a position in the direction of the general trend and against the retracement. It is important when using this strategy to be able to tell a trend from a retracement, though.
How to set up?
In order to set up and use Rainbow Moving Average you would want first to go click on the ‘Indicators’ button in the bottom-left corner of the screen and then on the ‘Moving Averages’ tab.
In the set-up window, there are several options available. First is the number of periods that will be used for the purposes of calculation. By changing the number of periods, you can either increase the indicator’s sensitivity by bringing the number down or decrease the number of false alarms by increasing the number of periods.
You can also choose the number of moving averages. It is important to find the right balance between the number of curves and ease of use. Most traders use 6 to 8. You can also choose the price type (open, close, high or low) and the moving average type that you will see. Close price and SMA — both are default parameters — are most commonly used.
Now, when you know how to set up and use Rainbow Moving Average in trading, you can proceed to the trading platform to give it a try and get first-hand experience!
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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