Some type of switch, either mechanical or hall effect. When the Arduino starts it rotates the dial until it senses the switch and then slowly backs up until the switch breaks and calls that 0 degrees. then you just send the arduino a position and let it move to that position. you will need to code for the 0-360 degree transition and how to handle going from 5 degrees to 355 and from 355 to 5.
Unless you buy an expensive encoder you will still have to go through an initialization routine as most encoders are incremental instead of absolute.