Mikula Forecasting Company

MarketWarrior: Using the Payoff Index

The Payoff Index is unique because it is one of the few indicators that uses both Volume and Open Interest (OI) in its calculation. Only futures contracts have OI data so this indicator is intended for trading futures. Some futures contract data does not include the OI number and the Payoff Index can not be used with that data. Futures contract data that does include the OI number, will include either the contract OI or the total OI for all contracts. If possible you should use the total contract Volume and OI and you will get better results with the Payoff Index.

The Payoff Index oscillates around a zero line. When the Payoff Index is rising it indicates that money is moving into this market. When the Payoff Index is falling it indicates that money is moving out of this market. To use the Payoff Index you want to watch for situations when the market is making higher tops but the Payoff Index is falling, indicating money is moving out of the market. You should also watch for the opposite situation when the market is making lower lows but the Payoff Index is rising, indicating money is moving into the market.

The chart below shows the interest rate futures contract, December 2008 Eurodollar. On this chart I have labeled the market top "A" and "B" for both the Payoff Index and the price data. Notice that the price top "B" was a higher top than "A". On the Payoff Index "B" was a lower that "A". This means the price made a higher high while the Payoff Index was falling indicating that money is moving out of the market. When you see this type of divergence and the market is rising while money is moving out of the market it indicates a top us due soon. After pivot "B" you can see the market continued to fall and money continues to move out of this market.



Here is another example of using the Payoff Index in MarketWarrior. The Payoff Index uses the Volume and Open Interest (OI) numbers so this indicator should only be used with futures contracts. If possible the total OI should be used and not the individual contract OI. You will get better results with total OI. The chart below shows the September 2008 Feeder Cattle futures contract. On the chart below I have labeled a bearish divergence situation. The labels "A" and "B" identify an upswing in the price data but a down swing in the Payoff Index. When the Payoff Index is falling it indicates money is moving out of the market. In this situation the price is rising while money is leaving the market. This indicates a market top may be coming soon. After top "B" the price fell to the bottom at "C" and the Payoff Index continued to fall indicating that money continued to move out of this market until bottom "C". When the price is rising but money is leaving the market it indicates a top is coming.