Herrick Payoff Index is useful for the early spotting of changes in price trend direction. So we can use the Payoff Index to distinguish trends that will most likely be short-lived from those that are destined to continue.
The Herrick Payoff Index is a good tool to forecast the money changes into future contracts. It uses analyzing of volume, price changes, and open interest changes to determine the amount of money flowing into or out of a futures contract.
The Index, when below zero, shows that money is flowing out of the futures contract and vice versa.
A multiplying factor is used to combine the value of each new day with the value of the previous day. So the value at the beginning of the data series is zero. The increase and decrease of the value depends on changes in the number of open contracts, the average price for each day, changes in the average price and the amount regulated by the trading volume.
A divergence from the price is the primary signal to watch out for. If the indicator is decreasing and prices are increasing, they will usually correct to confirm the indicator.
The index can also give coincident signals about a significant change in price trend a day or two before it occurs. This advance action is accomplished through use of trading volume and contract open interest to modify the price action. According to some analysts volume trends often change before a price-trend change. The relationships between the price trend and the trend of open interest is also possible.