I tend to prefer photodiodes or phototransistors for high speed work. A photo transistor works very much like a standard transistor, but with the incoming light acting as the base of the transistor. This allows for a much more significant voltage swing, making the sensor easier to read. You can actually find some nicely matched IR LED/Phototransistor pairs that might work well for your application at your favorite local electronics shop. (I'd recommend Lee's Electronics, were you in Vancouver... but that's a bit of a trip.)
Anyway, what you do is you basically make a voltage divider circuit. You hook the sensor (be it photoresistor, phototransistor, mechanical switch, what have you...) in series with a resistor. Usually a fairly high value resistor... 5 to 50kohms... will do nicely. If you are using a photoresistor you will have to match the value of the resistor to be roughly the same value as the photoresistor so that the junction between the two of them alternates between "something above 2.5v" and "something below 2.5v". (Assuming your chip is working at 5v, that is.) Again, phototransistors make getting this voltage swing much easier and much more reliable than photoresistors and I highly recommend you consider a phototransistor emitter/detector pair for your encoder.
In any case, hook it up like this...
You put your microcontroller pin to the junction between the resistor and the sensor. In this case, when light hits the sensor and it conducts, the junction between the resistor and sensor will fall to a lower voltage. When light no longer hits the sensor then the sensor will not conduct as much and the voltage will rise.
Whether or not this will read too quickly depends on how many pulses per revolution you have on your encoder. If you just have one pulse per revolution then you've only got 25 revolutions per second to deal with... if you've got 100 pulses per revolution (like, say, the VEX encoders do) then you've got 0.0004 seconds between each pulse. This is still quite "doable" for an arduino, but will start to become a hassle if you add multiple encoders and other time-sensitive sensors to your system.
Good luck... have fun, and did my subtle hint that you should try a phototransistor come through?