How To Position for a 10-Year Market Pattern Breakout

NEW YORK ( TheGoldAndOilGuy.com) -- Just before things took a dive on the weekend, the major market indices did not look promising.

If we take an even longer-term look and examine the monthly charts, we can see that the S&P 500 and the Dow Jones have been approaching multi-decade rising-channel resistance lines. Furthermore, they appear to be forming bearish rising-wedge patterns.

Monthly Long Term Chart Analysis and Thoughts

As many of my longer-term subscribers can attest to, I always preach that technical analysis is one part art and one part science. You can never be completely certain about what the outcome of a pattern is going to be. However, we can use historical analysis to make better investments. The great American Novelist Mark Twain probably said it best when he said "history does not repeat itself, but it rhymes."

Regarding a rising-wedge pattern, we know that roughly two-thirds of the time they break to the downside. This also means that one-third of the time they break to the upside.

To accomplish our goal of capital growth, we must do a number of things. We must make returns on our investments, we must protect our investments, and we must limit our losses. While all three aspects work in tandem with each other, there are times when focus must be given to one specific approach.

Regarding the current technical setup, I'm not so focused on the 67% chance that these wedges will break to the downside, but more so the impact of each outcome on the average Joe's portfolio and mom and pop businesses.

The S&P 500 and the Dow are approaching long-term resistance lines that have been in place for decades. If we do break to the downside, which I suspect we will, there could be a very significant sell-off with consequences that no one can predict at this point, though I mention some potential ones in the chart above. Alternatively, there is significant overhead resistance in the various indices, and I don't believe an upside break would be too monumental.

That being said, I always like to keep an open outlook and wait for the right opportunity. I'm trying to think of scenarios that would preclude further upside action, and I really am not coming up with much.

As evidenced by the completion of the recent five-wave uptrend on the S&P that coincided nicely with the various quantitative easing policies, Ben Bernanke and the Fed have had less and less impact. I truly can't see many fiscal developments that would prompt any significant bullish action.

The only scenario that I really think could pump up equities is a series of positive earnings announcements. A lot of expectations, earnings numbers and guidance figures have been revised downwards over the last couple of quarters, so there is the opportunity for some positive surprises that could lead to some bullish price action. In the absence of such a scenario, I really can't think of much else that would prompt a run up.

Look at these charts of positive and negative earnings surprises. Look at the dates and remember what happened afterward.

Positive Earnings Surprise

Negative Earnings Surprise

I am recommending two courses of action. For those steadfast bulls, lock in some profits or buy some protection. Missing out on some upside is a lot better than losing some of the gains you have fought so hard for over the past couple of years.

For more aggressive traders and investors, start following my updates a little more regularly as I foresee many shorting opportunities coming up in the future. As many of you know, sell-offs are often quick and abrupt, and timing is extremely important when playing the downside.

Trading could get very volatile in the near future. Historically and, even more so, looking forward, as August and September have been very costly for the average investor, our focus will be on taking the highest probability trades that offer the best risk-to-reward scenarios.

There will be times when we miss trades, and times when they're not timed perfectly. But as those who have been with me for a while can attest to, patience pays off in the long run.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Chris Vermeulen is founder of the popular trading sites www.thegoldandoilguy.com and www.ActiveTradingPartners.com. There he shares his highly successful, low-risk trading method. Since 2001, Chris has been a leader in teaching others to skillfully trade in gold, silver, oil and stocks in both bull and bear markets.