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JUSTIN NIELSEN

How To Shrink The Risk In Cathie Wood's ARKK

When you look at the ARK Innovation ETF managed by Cathie Wood, it's striking both for the phenomenal move up and the spectacularly awful drop.

So is it an instrument to be avoided completely? Not necessarily. In terms of swing trading, we have our own risk management rules. As such, we are trading it when it is strong and we don't need to rely on Cathie Wood to get us out when it's weak. Here's how we've handled it recently and why ARKK is still on our radar.

Cathie Wood And The ARKK Mandate

As with any thematic ETF, it's important to know what you are getting into. ARKK is specifically targeted at disruptive technology. Cathie Wood often shares that she's looking years into the future of what these companies could become. By its nature, that's speculating on future valuations and not necessarily where these companies stand today.

Cathie Wood became wildly popular as she rode many of these companies to dizzying heights after the Covid pandemic hit. From the April 6, 2020, follow-through day to a top in many growth names in February 2021, ARKK saw a 261% rise.

But those themes that capture the imagination of investors can also fall hard when investors' appetite for risk sours. As that happened, ARKK saw an 82% drop from its February 2021 peak to its low at the end of 2022. Cathie Wood lost her hero status and was often blamed for poor risk management. But at the end of the day, a thematic ETF has a mandate just as a mutual fund does. Investors don't look to ARKK to have a large cash position or invest in slow defensive names you might find in the SPDR Consumer Staples ETF. It's a bit more "ride or die."

Create Your Own Risk Management

But as an individual investor, that doesn't mean you need to take the same approach. Because ETFs are so easy to buy and sell, you can apply risk management better than Cathie Wood. While growth names had big performance on the postelection bump, the Fed reaction on Dec. 18 knocked them hard (1). We looked at the upside reversal in ARKK shortly afterward (2) as a good sign that a quick recovery might ensue. Once we saw the reversal get a boost of strength around 60, we added ARKK to SwingTrader (3).

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In just a couple days, our optimism waned as the ETF fell below our entry day low (4). Earlier that day as stocks started turning down, we locked in a small gain on our ARKK position recognizing its vulnerability. We didn't need Cathie Wood to employ risk management. We had our own.

The exit saved us from a drift lower and an undercut of the initial upside reversal. But eventually, ARKK found support around its 50-day moving average line and it looked interesting again (5).

Another Try, Another Exit

After finding support at the 50-day line, ARKK powered back above its 21-day line and we added it back to SwingTrader (6). This time we got some early progress and started taking some profits into strength (7). Especially with quicker moving stocks, ETFs and even market environments, taking some profits on strength can help you weather future storms. Indeed, the next day saw what looked like another failure as it quickly fell below its 21-day line (8). Since we had nearly a 4% gain come all the way back to our entry, we exited the remaining position to minimize the damage.

You can have a lot of small gains and losses in this way where you don't get hurt. If one of those works, we can easily get a gain that will more than make up for the small losses. Because we keep them small.

While it is unlikely we'll be able to ride ARKK all the way up if it has a 2020-like move, we certainly won't join Cathie Wood in a 2021-like destruction.

More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.

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