Anyone beginning to learn about investing will soon hear the phrase “sector rotation.” Different types of industries perform better during specific stages in the economic cycle. For example, some industries take off when the economy is expanding, while others actually profit more when the economy is in a slump. That means that investors can always find a way to profit in the markets, as long as they know where to look.

To capitalize on sector rotation, you first need to get a handle on the sectors themselves. Essentially, a sector is a unique industry group. A lot of people — including financial professionals — use the terms sector and industry interchangeably, but they aren't really the same. Industry describes a specific set of businesses, while sector is a broader term. In fact, a sector is technically a broad section of the overall economy and can include more than one industry. For example, the financial sector includes banking, investment banking, mortgages, accounting, insurance, and asset management — six distinct industries.

Next you'll need to know at which point in the cycle the economy currently stands: downturn, recession, upturn, or recovery. You can find current economic analysis in most of the big financial newspapers, such as the Wall Street Journal. You can also find detailed information on the state of the U.S. economy from the Bureau of Economic Analysis at www.bea.gov. Once you know where the economy is, you can better predict where it's going to go from there, even if you can't predict the timing. That's because the economic cycle follows a very definite pattern. For example, when the economy is in a deep recession, the next phase of the cycle will be an upturn, a very good time to begin investing more actively. That knowledge, combined with a grasp of sector rotation, can help you profit regardless of the prevailing economic state.

Sector rotation describes the movement of profitability through different sectors as the economy goes through its cycles. Different sectors thrive in different portions of the cycle. The basic sectors are highly predictable, following the economic cycle like clockwork. For example, the utilities and services sectors tend to perform well during an economic downturn; and as that downturn segues into a full recession, the technology, cyclicals, and industrial sectors will start to flourish. As the economy begins to turn toward recovery, basic materials and energy perform best. In a full thriving economy, the consumer staples sector will really take off. So if you know what stage the economy is in now, you know where in the cycle it will be going next, and you can reasonably predict which sectors will prosper.