Technical Analysis -herrick_payoff

Technical Analysis from A to Z

by Steven B. Achelis

HERRICK PAYOFF INDEX

Overview

The Herrick Payoff Index is designed to show the amount of money flowing into or out of a futures contract. The Index uses open interest during its calculations, therefore, the security being analyzed must contain open interest.

The Herrick Payoff Index was developed by John Herrick.

Interpretation

When the Herrick Payoff Index is above zero, it shows that money is flowing into the futures contract (which is bullish). When the Index is below zero, it shows that money is flowing out of the futures contract (which is bearish).

The interpretation of the Herrick Payoff Index involves looking for divergences between the Index and prices.

Example

The following chart shows the British Pound and the Herrick Payoff Index.

The trendlines identify a bearish divergence where prices were making new highs while the Payoff Index was failing to make new highs. As is typical with divergences, prices corrected to confirm the indicator.

Calculation

The Herrick Payoff Index requires two inputs, a smoothing factor known as the "multiplying factor" and the "value of a one cent move."

The multiplying factor is part of a smoothing mechanism. The results are similar to the smoothing obtained by a moving average. For example, a multiplying factor of ten produces results similar to a 10-period moving average.

Mr. Herrick recommends 100 as "the value of a one cent move" for all commodities except silver, which should be 50.

The calculation of the Herrick Payoff Index ("HPI") is:

Where:

Note that in order for the rise/run values (e.g., 1 x 1, 1 x 8, etc) to match the actual angles (in degrees), the x- and y-axes must have equally spaced intervals. This means that one unit on the x-axis (i.e., hour, day, week, month, etc) must be the same distance as one unit on the y-axis. The easiest way to calibrate the chart is make sure that a 1 x 1 angle produces a 45 degree angle.

Gann observed that each of the angles can provide support and resistance depending on the trend. For example, during an up-trend the 1 x 1 angle tends to provide major support. A major reversal is signaled when prices fall below the 1 x 1 angled trendline. According to Gann, prices should then be expected to fall to the next trendline (i.e., the 2 x 1 angle). In other words, as one angle is penetrated, expect prices to move and consolidate at the next angle.

Gann developed several techniques for studying market action. These include Gann Angles, Gann Fans, Gann Grids and Cardinal Squares.

Example

A Gann Fan displays lines at each of the angles that Gann identified. The following chart shows a Gann Fan on the S&P 500.

You can see that the S&P bounced off the 1 x 1 and 2 x 1 lines.

This next chart shows the same S&P 500 data with a Gann Grid.

This is an 80 x 80 grid (each line on the grid is 1 x 1 and the lines are spaced 80 weeks apart).