No matter what the market conditions are, there are always winning and losing stocks. There are those companies that have the right model at the right time. The trick right now is to find the rising stocks in this falling market.

For years I have been hearing from proponents of sector rotation in portfolio management; that is, shifting out of one sector as it falls and into another sector as it rises. As the economy starts to slow, money starts to rotate out of inflation-sensitive groups like basic materials and energy. Basic materials typically peaks first and energy last, or so the theory goes.

Unfortunately, a lot of the theory behind this type of strategy is based on backward-looking analysis. Researchers sit in a room and analyze 50 years of stock market data and find if you moved from sector A to sector B with the occurrence of economic event 1, you would have had some huge returns. They never really get into the specifics of how you can identify the next occurrence of said economic event. It’s the kind of thing that looks really good in a journal, but has no true practical application.

Exactly where we are in the business cycle is a matter of some debate and, without a concrete answer, you don't know when to shift sectors. It would appear that the economic cycle is on a downward slope and not anywhere near a trough. This would indicate that the market should be near a bottom and could begin a period of sideways movement. It could also mean we are in for further reductions in the market.

When looking for the booming and busting sectors, good indicators are the exchange-traded funds, or ETFs. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Watching ETFs set to track certain sectors can give you an idea about where the money is being made in the market. Once you find an ETF moving in a sustainable uptrend, you can check out which stocks are moving the fund up and stay away from the stocks holding it back.

Take a look at how the ETFs out there can be used to gauge how different sectors are fairing in the market. Select Sector SPDR Energy Fund (AMEX: XLE, Stock Forum), which holds 40 energy stocks in the S&P, fell as crude fell from its high to $130 a barrel. The ETF has slipped below key support at the 10-week and 40-week moving averages.

Lately, we have seen energy stocks falling a bit as supply concerns for oil ease. Companies like Exxon Mobil (NYSE: XOM, Stock Forum), Chevron (NYSE: CVX, Stock Forum), and Baker Hughes (NYSE: BHI, Stock Forum) have seen share prices fall in the past few months. This is most probably a temporary circumstance and we will likely see energy stocks begin to rise in the near future. This will occur on two seemingly opposed but connected fronts. As oil prices flatten or rise, oil production, service, and refining companies will move higher again.

Because of the higher oil and gasoline prices, alternative energy companies will see increased investment. Suntech Power (NYSE: STP, Stock Forum), First Solar (NASDAQ: FSLR, Stock Forum), and Thomas & Betts (NYSE: TNB, Stock Forum) are a few companies poised to benefit. As a result of this investment, both governmental and private, these companies should be able to achieve some significant and quantifiable results. These results will result in higher profits and rising stock prices.

This is all really longer-term stuff and, on the part of the alternative companies, rather speculative. There is a place for these types of plays in your portfolio, but that is a topic for another article.

While all this was going on, the SPDR Financial Select Sector (AMEX: XLF, Stock Forum), which tracks that sector of the S&P 500, undercut a six-year low before rallying. It's trading 46% below its all-time high in May 2007. Financials look as if they are extremely oversold. There could be some gems in this sector ready to soar as the dogs fall by the wayside.

While IndyMac (OTO: IDMC, Stock Forum) struggles to keep any vestige of hope alive, JPMorgan Chase (NYSE: JPM, Stock Forum), Citigroup (NYSE: C, Stock Forum), and Bank of America (NYSE: BAC, Stock Forum) all posted better-than-anticipated numbers. This may be the time to consider getting back into financials. Bank of America saw its second-quarter earnings fall year over year, but managed to beat estimates for the quarter.

By looking at the ETFs, we can see what appears to be a shift from energy to finance. There are many ways to play this knowledge, but we will look at the two most obvious here.

We can move some money into financials since they appear to be on the rise. A hedged trade will give us some cushion, should the stocks turn back down or the market have a major sell off.

Another choice would be to open a hedged trade on one of the energy companies with enough protection to absorb any downward action in the next few months. Either strategy is viable and could generate some good profits through the end of the summer.

In the financial sector, you may want to consider a hedged trade on BAC. Look at the September 22.50/20 Call Debit Spread for a 2.10 debit. This trade has a potential 19% return, and the stock could fall more than 22% and not hurt the position.

For an energy trade, you may want to consider an October 70/65 Call Debit Spread on XOM. Going for a 4.40 debit results in a 13.6% return with over 13% downside protection.

This is a volatile market so be sure any trade fits into your unique portfolio. Do your homework before you trade, and always try to have some fun.

This week Investors Observer covers:
Where are the positive sectors in this Unsure Market and how can investors play those companies?

Articles:
* What Company is Repositioning for the Staycation Fad + Lee’s take on XOM, UAUA, DIS, AXP, MAR, and RCL.
* How Can You Find Winners When The Market Loses?  
* Where Are The Bulls In This Bear Market?
* Which Trades Are Best Suited For A Rebounding Market?

Click here to read any of these articles.

Vic Wisemann is an equity option strategy analysts with Investors Observer. Mr. Wiseman manages several portfolios for the company and comments weekly on his insights, strategies, and tactics for playing the market to win.

DISCLOSURE: Mr. Wisemann owns and/or controls diversified portfolios of long and short stock and option positions that may include holdings in companies he discusses in his articles.