The Rainbow strategy

The Rainbow strategy is based on the Rainbow indicator. The Rainbow indicator is a variation of the Guppy Multiple Moving Averages indicator designed by trader Daryl Guppy. The Rainbow strategy is an easy and straight-forward trading concept. The strategy can be used with any instrument and in time frame.s

Suitable for : All instruments
Instruments : Futures, CFD-Forex, stocks
Trading type : Day trading and swing trading
Trading tempo : Variable
Using NanoTrader Full : Manual or (semi-)automatic

The Rainbow indicator consists of no less than 22 EMAs (exponential moving averages) ranging from 9 periods up to 100 periods.

The Rainbow indicator trading strategy.

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The Rainbow strategy trades pullbacks. A pullback is a market which is in a trend but which temporarily moves in the opposite direction. After a pullback the market tends to resume its main trend.

When a pullback returns to trend, it can often be a strong movement. These strong movements are interesting for traders. The Rainbow strategy visualizes pullbacks by indicating how far the market pulls back into the ”rainbow”.

When to open a position?

A position is opened when the market price pulls back inside the rainbow, and crosses below a certain number of the 22 EMAs. The trader can select the specific EMA below which the market price must drop. Given there are 22 EMAs, 11 is half-way through the rainbow and 22 is the bottom of the rainbow. The deeper the trader allows the market price to pull back into the rainbow, the stronger the potential return to trend will be, but the higher the risk of a real trend reversal.

In this example the market is in a bullish trend. The trader selected the 11th EMA as the pullback signal level. The EMA selected is indicated by a black line. When the market price crosses below the 11th EMA a buy signal occurred. The buy signal is by the black candle and the vertical green bar. The market price returns to trend after the signal.

The Rainbow indicator trading strategy showing a buy signal.

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In this example the market is in a bearish trend. The trader is looking for pullbacks, which may provide a short sell opportunity. The trader selected the 17th EMA as the pullback signal level. When the market price crossed above the 17th EMA (black line) a short sell signal was generated. The signal is indicated by the black candle and the vertical red bar. It was a clear pullback with the market returning to trend immediately after the signal.

The Rainbow indicator trading strategy showing a short sell signal.

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But what in a sideways market when there is no clear trend? How can the trader make sure there is a strong return to the trend? The Rainbow strategy contains a very intelligent signals filter: the slope of the fastest EMA. This is the 9-period EMA in red.

The trader can indicate in percent the slope he wants the 9-period EMA to have after the signal i.e. a steep slope indicates a strong, fast return to trend.

This example shows several occasions when the market price crossed below the selected EMA. Because the fastest EMA (top red line) did not have an upward slope – it was actually going down – after the cross, the platform did not give buy signals. In this example the required slope was set to 0,01%.

The Rainbow indicator trading strategy with filter.

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When to close a position?

The Rainbow strategy uses a profit target order and a stop loss order:

  • The initial stop loss is placed on the low of the last 5 candles. The stop starts to trail the market price if the slowest EMA goes above this initial stop level.
  • The profit target is a multiple of the initial risk. The default setting for the profit target is 2x the initial risk. As usual, the trader can change this setting in the DesignerDialog.

This example shows a buy signal.  The initial stop loss order was placed on the lowest price of the last five candles back. When the slowest EMA moved above this initial stop level, the stop order started to trail the market by following the slowest EMA. Notice the stop order following the EMA step-by-step. All order management is automated in the NanoTrader platform. The profit target was placed at a distance 3x the initial risk. The profit target (green line) was reached and the position closed with a profit.

The Rainbow indicator trading strategy: stop loss and price target.

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This example shows a short sell signal. The initial stop loss order is placed on the highest price of the last five candles back. The profit target is placed at a distance of 3x this initial risk. The profit target is quickly reached.

The Rainbow indicator trading strategy: stop loss and price target when short selling..

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The Rainbow strategy is a very easy and straight-forward trading concept. It can be used with any instrument and in any time frame. In case the market trend is not strong, the slope parameter is used to reduce the number of signals significantly.

Practical implementation

Using the NanoTrader Full follow these steps:

  • Open a chart of the instrument you want to trade.
  • Select the template study "WHS Rainbow” in the "WHS Strategies" folder.
  • If required, adapt the parameters as described above.
  • To trade semi-automatically, activate TradeGuard+AutoOrder in the chart. To trade automatically, activate AutoOrder in the chart.