Green means go

They key is focusing on the sectors showing strength. At the same time, by focusing on where the action is and shedding underperformers, you can reduce your overall stock holdings while keeping pace with benchmarks like the S&P 500. Because you're not putting capital into underperforming sectors, you can maintain a larger cash reserve without missing out if the market takes off.

Easier said than done, right?

To help you along, I want to share one of the tools I created for the benefit of my newsletter subscribers: A collection of charts showing the performance of major sectors versus the broad market. You can access it for free at stockcharts.com.

Here's one chart, tracking energy against the S&P 500:

XLE: $SPX © StockCharts.com

The setup is a bit technical, but the display style makes it simple to see strength and weakness. You invest in sectors only when they are demonstrating outperformance via the following conditions:

  • The price bars (shown above in green, blue or red) are green.
  • The price is above the nine- and 18-day moving averages.
  • The nine-day average is above the 18-day average.
  • The MACD indicator in the lower pane is above the zero line and rising.

I also like to focus on sectors where relative price is pushing on the upper Bollinger band (which is the shaded gray area). The chart above illustrates how the energy sector is on a buy signal right now, as it meets all the conditions. A buy signal was triggered in the first week of July.

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Based on these criteria, the tool would have investors focused on energy and technology stocks this month while avoiding transportation, health care and industrials. Here's the month-to-date performance of these sectors, represented by exchange-traded funds:

  • Energy Select Sector SPDR (XLE): 5.3%
  • Technology Select Sector SPDR (XLK): 4.3%
  • Health Care Select Sector SPDR (XLV): -1.4%
  • iShares Dow Jones Transportation (IYT, news): -2%
  • Industrial Select Sector SPDR (XLI): -2.8%

For reference, the S&P 500 was up 1.1% over this period.

Using this strategy has helped the Edge Portfolio (which I maintain for my subscribers) post a 14% gain over the past three months versus a 2% loss for the S&P 500. It works.

Advanced investors and traders can take the strategy one step further by scouring for the strongest stocks within the strongest sectors. In energy, two examples I've recommended to my newsletter subscribers are SandRidge Energy (SD, news) and Hyperdynamics (HDY, news), which are up more than 9% and more than 23%, respectively, since adding them to the portfolio earlier this month.

Hyperdynamics is also being tracked in real time hereas part of my sample portfolio for MSN Money readers.

Summing it up

There are three takeaways here. The first is that the market is becoming a dangerous place, with higher volatility, political uncertainty and more extreme potential outcomes. The second is that the usual safe havens like bonds and gold aren't as safe as they might seem. The third is that a strategy of narrowing your focus to the strong areas of the stock market seems like the solution.

Yes, it will be more work than holding on. We won't be able to let our 401ks and individual retirement accounts sit still. But I think the rewards will justify the effort, especially in these uncertain times.

Even if the debt ceiling ignites another panic, carrying a cushion into the event, courtesy of the gains in tech and energy, gives us the luxury of staying invested -- and preparing for the epic market rally that should follow an eventual political compromise, even if it comes at the last minute.

At the time of publication, Anthony Mirhaydari owned or controlled shares of Hyperdynamics. He has recommended Hyperdynamics and SandRidge Energy to his newsletter subscribers.

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.