Moving AveragesChapter 5

Moving Averages

Moving averages smooth price data to identify the underlying trend direction. They are the most widely used technical indicators, serving as dynamic support/resistance levels and generating trend-following signals through crossover systems.

Last updated: 29 July 2026

Prerequisites

This sheet builds on the trend concepts covered in "Trends, support and resistance" (ch. 2, Easy level). Uptrend, downtrend and range all need to be understood before moving averages can be used effectively.

Definition

Murphy defines the moving average in chapter 9 (1999 edition) as the average price of an asset over a defined period, recalculated with each new period. The result is a continuous line that smooths out the erratic swings of price to bring out the market's underlying direction.

There are three main types:

The SMA (Simple Moving Average): the arithmetic mean of the last N closes. Every data point carries the same weight. Formula: SMA(N) = (C₁ + C₂ + ... + Cₙ) / N, where Cᵢ is the closing price of period i

The EMA (Exponential Moving Average): applies exponentially decreasing weight to older data, and so reacts faster to recent price changes. The smoothing factor is k = 2 / (N+1). Formula: EMA = (Close × k) + (previous EMA × (1−k))

The WMA (Weighted Moving Average): applies linearly increasing weight to recent data, sitting between the SMA and the EMA in responsiveness

Murphy holds that the choice between SMA and EMA depends on the trader's horizon: the EMA suits shorter timeframes, since it reacts faster, while the SMA is preferable for identifying underlying trends, since it filters more noise.

Why it matters

Murphy devotes a full chapter to moving averages because they are the most versatile tool in the technical toolkit. They serve simultaneously as a trend filter (the MA200 is the world's reference for institutional investors deciding whether a market is bullish or bearish), as dynamic support and resistance (price bounces off the MAs regularly in a trend), and as a signal generator (golden and death crosses are among the most closely watched signals anywhere).

Murphy stresses that moving averages work particularly well in trending markets but lose their effectiveness in ranges, where crossovers generate a stream of false signals. He therefore recommends always combining MAs with other tools that establish whether the market is trending or ranging.

Key points

Murphy recommends three fundamental periods: the MA20 (short-term trend, about a month of trading), the MA50 (intermediate trend, about a quarter) and the MA200 (long-term trend, about a year). These three cover Dow's three horizons — minor, secondary, primary

The relative position of the three MAs indicates the strength of the trend: in a strong uptrend, MA20 > MA50 > MA200 with widening separation (the MAs "fan out"). A tightening of the three signals a transition or a consolidation

A crossover between two MAs is a lagging signal by construction. Murphy recommends using crossovers to confirm a trend already identified through price analysis, not as a standalone entry signal. The lag can run to several weeks, especially with the MA200

Moving averages act as price magnets: when price moves far from its MA (over-extension), it tends to come back. Murphy uses the gap between price and the MA200 as a measure of how stretched the market is. A gap above 15-20% is unsustainable over the long run

Concrete example

Examples

The golden cross of 1 July 2020 on the S&P 500 — when the MA50 crossed above the MA200 — signalled the start of a historic rally. Despite a considerable lag (the market had already rebounded roughly 40% from the 23 March low), the golden cross correctly identified a new primary uptrend that ran for nearly two years, carrying the index from around 3,130 to 4,800. Conversely, the death cross of March 2022, when the MA50 dropped below the MA200, correctly anticipated the continuation of the 2022 bear market (a further −15% after the signal). Murphy notes that across the last 30 golden and death crosses on the S&P 500, the direction indicated proved correct in roughly 75% of cases over a six- to twelve-month horizon.

Common mistakes

Caution

Using moving averages in a trendless market. MA50/MA200 crossovers then generate costly whipsaws. Murphy recommends pairing MAs with a trend-strength indicator (the ADX, for instance) to filter out ranging periods

Piling on so many MAs that the chart becomes unreadable. Murphy advises a maximum of three (20, 50, 200), each matching a different time horizon

Treating golden and death crosses as instant signals when they are lagging by construction. Price has often already moved significantly by the time the cross occurs

Forgetting that long MAs (100, 200) are far more meaningful than short ones (5, 10), which generate considerable noise

Practical note

Murphy

Murphy recommends using the MA200 as an absolute strategic filter before any position is taken. His rule is simple: only take long positions when price is above the MA200, and short positions when it is below. This elegant filter removes the majority of counter-trend signals, which are the main source of losses among private traders.

Market impact

Markets

The S&P 500's 200-day moving average is the single most closely watched technical level in global markets. When the index moves below it, pension funds, insurers and hedge funds trigger large asset reallocations. Golden crosses and death crosses on the major indices are covered as a matter of course by the financial press (Bloomberg, Reuters, CNBC) and produce measurable order flow. In 2022, the S&P 500's death cross coincided with net outflows of 50 billion dollars from equity funds.

Reference