How to Avoid Crashing as Market Rotates

NEW YORK (TheStreet) -- Think of the market as one big wheel. Sometimes it can seem like high performance tire on a high-speed sports car and other times it can seem like a giant grist mill grinding up your portfolio.

One of the tricks is to rotate along with the market as that giant wheel begins to turn. Markets are cyclical, asset classes are cyclical, sectors are cyclical, and stocks are cyclical. If you still believe in "buy and hold," then maybe this article is for you.

When the market is in full gear and your sports car is purring along, it is the risk-on stocks that are at the top of the wheel, while the inverse funds are at the very bottom of the wheel. During a time like this, you are loving life in the fast lane while those who are on the wrong side of the market are getting ground up.

Conversely, when the market begins to rotate, your sleek sports car can come to a screeching halt and start to rotate towards the bottom of the wheel, while those at the bottom begin to rotate upwards. If you do not how to recognize market rotation, you can easily give up hard-earned gains rather quickly.

If you can learn how to recognize market rotation, you can move methodically through the market, locking in hard-earned gains and moving into the areas of the market that are rotating upwards. Remember, everything is relative in the market. I track approximately 2,800 stocks and exchange trades funds, and I rank them every day based on performance and value. I try to stay within the top 200 overall. There are always a top 200 somewhere. In fact, I publish my top 200 in my newsletter each week. Click here to get four free issues.

Let me give you some examples. The market blasted off last October and peaked on April 2 of this year when the S&P 500 hit 1422.38. The market went on a real fun ride of about 30-35%. It was a great time to have your convertible top down and let the sun shine into your portfolio. I had my clients fully invested all along the way. During my 18 years as a professional money manager, I have learned that you have to make money while the sun is shining in the market.

While I was enjoying the ride, I heard the naysayers at every turn in the road. There have always been perma-bears in the market. They have never made me any money. Then there are those who are just downright nervous all the time and always looking for an excuse to be on the sidelines. Let the market dictate whether you should have your foot on the accelerator or on the brakes. Let's take a quick look at that six-month uptrend:

You can see the uptrend that I am talking about in the chart above. You can also see the topping out and double-top that occurred in April.

During the uptrend it was go-go type stocks that dominated my top 200 list on a daily basis. I think it is fair to say that Apple ( AAPL) was the standard bearer during this nice run in the market. Apple was the Ferrari leading the market higher.

Apple made a parabolic move as it led the charge upwards. While the S&P was up about 30% during this time period, Apple was up 84%! Man, what a ride! I hope that you were in the car next to me! Not only was it Apple that was scorching up the track, but it was also stocks like Monster Beverage ( MNST), Polaris ( PII), Dollar Tree ( DLTR), Priceline.com ( PCLN), Sturm Ruger ( RGR), Ross Stores ( ROST), TJ Maxx ( TJX), etc., etc. I hope you enjoyed the ride in some of these stocks also. I wrote many articles about them along the way.

I have learned from experience that parabolic moves don't end very well. We witnessed a parabolic move in dot.com stocks back 1999-2000. I remember having a 45% quarter in late 1999. We witnessed a parabolic move in home price in 2005-2006. Most of us were rich with equity and pulling money out by the armload back then.

When Apple crossed $600 and I started hearing about Wall Street firms initiating coverage with $1,000 plus target prices, my antenna started going up. One of my selling rules is as follows: There is nothing wrong with getting out while the going is really, really good. An 84% move in six months qualifies as really, really good! I hope it was as good for you. I sold half of my large Apple position at the time.

It was not long after that Apple peaked for now and started to roll over. The standard bearer was now starting to turn, would the market turn with it? As it turns out, yes the market did start to turn with Apple. No, it was not all the parabolic move in Apple to blame. Other factors like weakening jobs numbers, turmoil in Europe, profit-taking, and that always present "sell in May and go away" crowd helped turn the market from risk on to risk off within a matter of about four weeks.

Hopefully, you have been moving out of some of your positions that were good to you on the way up and are now starting to rotate down. It is also extremely important to know what is filling those top 200 positions right now.

It should come as no surprise that defensive stocks are rising up the ladder in a real hurry. I wrote about Tanger Factory Outlets ( SKT), Textainer ( TGH), and Avalonbay Communities ( AVB) in an article last week here on the TheStreet. Take a look at how Tanger has been moving up in rank over the last 30 day.

Also note, the superior performance of Tanger over the last 1,3,5, and 10 years. This is also a big contributing factor to this stock being highly rated right now.

Now let's contrast a rising stock like Tanger, with a stock that has been rotating out of favor. I had a huge gain in Terra Nitrogen ( TNH) after holding it for about one year. In fact, I called it the dividend stock of the decade in an article I wrote in back in January. The stock was trading at around $180 at the time. It topped out at $298 five months later and then started to roll over and drop in rank.

I locked in a very nice profit and moved on. Look at how the stock has dropped in rank since then.

Also look at how the chart has disintegrated:

How is your sell discipline?

Lastly, I want to show you a very important asset class from time to time in the market. Inverse funds can come in very handy when the market really starts to rotate like it is now. Inverse funds have been buried at the bottom of heap for the last six months, but have been moving up rapidly in the last four weeks. Have a look at EFU, which is a double-inverse fund on the MSCI EAFE index. Is not Europe the eye of the hurricane right now?

Can you believe that this ETF has risen from 2,138 to number 33 in the last 30 days? Now, that is a Ferrari-like move. Take a look at the chart:

Can you spell H-E-D-G-E?

Market rotation will continue to happen as long as there is a market. If you can learn to spot it, it can make life a whole lot easier!

Disclosure: At the time of publication, Bill Gunderson was long DLTR, ROST, TJX, EFU, SKT and TGH.

You can follow Bill on twitter @billgunderson or write to him: bill@pwstreet.com

More from Opinion

These 5 Tech Giants Still Aren't That Expensive

These 5 Tech Giants Still Aren't That Expensive

Intel CEO Brian Krzanich's Ouster Proves CEOs Aren't Above the Rules

Intel CEO Brian Krzanich's Ouster Proves CEOs Aren't Above the Rules

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others