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HERRICK PAYOFF INDEX
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The Herrick Payoff Index (HPI) is an indicator developed by John Herrick, a technical market analyst from California . He taught it privately, but the indicator became more popular after it was included in CompuTrac software in the early 1980s.

The Herrick Payoff Index helps detect accumulation and distribution. Most indicators measure only prices, some measure volume, but HPI tracks open interest as well as prices and volume. HPI confirms valid trends and helps catch their reversals.

How to Construct HPI

The Herrick Payoff Index may be calculated using several types of daily data. You may use a single contract with its own price, volume, and open interest. It is more practical to combine volume and open interest from all contracts and apply them to the prices of the most active delivery month.

HPI uses daily high and low prices, volume, and open interest. It requires data for at least three weeks before it begins producing meaningful numbers. Its complex formula makes using a computer almost a necessity (see worksheet, Figure 35-1).

where Ky = yesterday's HPI.

K = [(M-M y ) • C • V] • [1 ± {(/ • 2)/G}] and M = mean price — i.e., (High + Low)/2.

My = yesterday's mean price.

C = the value of a 1-cent move (or use the same constant for all contracts).

V = volume.

Traders can apply HPI only to daily data and not to weekly or intraday data. There is no such thing as weekly open interest. Weekly volume can be obtained by adding up daily volume for five days, but open interest cannot be added up.

Crowd Psychology

The Herrick Payoff Index measures mean prices rather than closing prices. Daily mean prices represent the average consensus of value for the day.

Volume represents the degree of financial commitment in a given market. When volume increases, the absolute value of HPI for that day increases.

Daily changes in open interest represent the flow of funds into and out of the market. Rising open interest is bullish in an uptrend and bearish in a downtrend. Falling open interest is bearish in an uptrend and bullish in a downtrend. Flat open interest is essentially neutral.

Trading Rules

The Herrick Payoff Index gives several types of trading signals, listed here in the order of importance. Divergences between HPI and prices identify some of the best trading opportunities (Figure 35-2). When HPI breaks its trendline, it gives an early warning that a price trendline is likely to be bro­ken. When HPI crosses its centerline, it confirms new price trends.

•  When prices fall to a new low but HPI makes a higher bottom than
during the previous decline, it creates a bullish divergence and gives a
buy signal. When HPI turns up from its second bottom, buy and place
a protective stop below the latest price low.

•  A bearish divergence occurs when prices rally to a new high but HPI
makes a lower top. The signal to sell short is flashed when HPI turns
down from its second top. Place a protective stop above the latest high
price.

Important divergences develop over the course of several weeks. A divergence that takes two months to develop is more powerful than the one in which two weeks passed between the tops or bottoms. Pay attention to the differences in the height of the adjacent HPI tops or bottoms. If the first top or bottom is far away from the centerline and the second top or bottom is near that line, that divergence is likely to lead to a greater move.

Bullish and bearish divergences of HPI often have long lead times. Once you have identified a potential turning point using an HPI divergence, lean on short-term oscillators for more precise timing. If a divergence between HPI and price aborts, and you get stopped out, watch closely—you may get an even better trading opportunity if a regular divergence turns into a triple bullish or triple bearish divergence. Triple bullish divergences consist of three lower bottoms in prices and three higher bottoms in HPI. Triple bearish divergences consist of three higher tops in prices and three lower tops in HPI. They occur at some of the major turning points in the markets.

3. HPI lends itself well to classical charting methods, especially trend lines. When trendlines of prices and HPI point in the same direction, they confirm trends. HPI often breaks its trendline before prices break theirs. When HPI breaks below its uptrend, it gives a sell signal. When it breaks above a downtrend, it gives a buy signal. Then it pays to either take profits or to tighten stops.

4. The position of HPI above or below its centerline shows whether bulls or bears dominate the market. When HPI is above its centerline, it shows that bulls are in control —it is better to be long. When HPI is below its centerline, it is better to be short. Bulls may buy or add to

their long positions when HPI rises above its centerline. When HPI declines below its centerline, it confirms downtrends.

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