The palette shows the four folks currently assigned to the Button Circle, Button x, Button Square and Triangle buttons corresponding to the four circles in the top-right of the screen.
Interface Palette

If you would like to use the folk in the circle at the top, simply press or hold the Triangle buttton to attack or guard. Note that this will only work if you have enough MC to attack with.
Folks can be added or removed from the palette by pressing Button L2 to open the Change Folks Screen. On this screen, simply scroll left, right, up or down then press one of the Button Circle, Button x, Button Square or Triangle buttons on the folk you want, press Button L2 again to close the screen.

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