The Herrick Payoff Index is one of the only technical indicators to combine price, volume, and open interest data for the analysis of futures, commodities, and derivatives. The Herrick Payoff’s main function is to elucidate whether money is flowing into – or out of – the derivative instrument in question. It can be useful for spotting divergences that may occur before prices change direction, or for confirming price trends.

One of its most significant parameters is a user-set value of a one-percent move, called pointValue. Herrick recommended 100 for most commodities at the time that he developed it, but users should experiment to find the setting that best fits the instrument they are trading in today’s environment.

Some modern analysts recommend setting the pointValue to 500 for Financials and 250 for most commodities. Users also determine a smoothing factor for the number of periods that are to be included in the calculation. The Index value will fall between 1 and -1, with values over zero indicating bullish activity (with money flowing into the instrument), and values under zero indicating bearish activity (with money flowing out of the instrument).

As seen in the accompanying chart, trends in positive and negative directions, as well as peak and trough levels in comparison to the preceding peaks and troughs, can be useful confirmation of divergences that may lead to profitable trades preceding price activity. (If you are not familiar with the concept of Open Interest, see our article answering the question “What is Open Interest?”)

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When the Herrick Payoff Index (HPI) dips below the zero line and is seen in a sustained descent, it could mean money will continue to flow out of the commodity or derivative instrument. A trader may consider cutting losses or purchasing derivatives to hedge against further decline. On the flip side, if the HPI is seen moving upward and crosses above the zero line, it could indicate new money flowing into the derivative or commodity, and a trader may want to consider going long or exploring call options or futures betting on a higher price. 

Like any technical indicator, the Herrick Payoff Index has some downsides – its future-first focus can lead to false signals, for example. That’s why it’s especially important to use the HPI in conjunction with other technical indicators. Fortunately, technology allows us to not only see and share trading information more quickly than ever before, but to automate trades using a disciplined technical strategy we define. Artificial intelligence tools from Tickeron can aid traders with trade ideas, help analyze signals to execute advantageous trades, and assist investors with making rational, emotionless, and effective trading decisions – an antidote to the limitations of technical indicators.

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