The Dow Jones Industrial Average's single-day 400-point drop may be weeks behind us, and thoughts may be turning toward this bull market that's pushed the Dow far into the record books. But I promise another huge decline is never too far off. It's during these cautious but optimistic times when investors should mentally prepare themselves for another bloodletting.

Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." I agree. An investor who embraces this axiom casts aside the bears and turns bullish in times of maximum pessimism.

The bloodiest days
Imagine picking up a company like TD Ameritrade (NASDAQ:AMTD), which was beaten down from all-time highs of $44.50 to nearly $3 during the broad sell-off of technology stocks in 2000 and 2001. Ameritrade today sells for approximately $20 per stub. That's a greater than 520% return. And sure, telling you to buy an Internet broker like Ameritrade in those days is grade-A 20/20 hindsight. But consider picking up the more stodgy Merrill Lynch (NYSE:MER) after its hair-raising drop in 2002. Your returns would still be a robust 210%. Even picking up shares of stalwart Goldman Sachs (NYSE:GS) at the same time would have netted you 270%.

The point is, you can easily profit from a ghastly investing environment. When everyone else is selling, it may just be the best time for you to step in and pick up a great company for cheap.

Sometimes the blood is your own
But Mark Mobius reported in his book Passport to Profits that there is a second part to Rothschild's quote -- one that is perhaps even more impressive and intellectually inspiring. Buy when there's blood in the streets, "even if the blood is your own."

That means being confident enough in your analysis to buy stocks you already own even when the market is telling you your analysis is wrong. And it's hard to do. There have been plenty of times when I have sworn off good companies when chips were down. In mid-February, I had my parents buy into Washington Mutual (NYSE:WM) only to see it drop 10% almost immediately, thanks in part to the actions of companies like Accredited Home Lenders (NASDAQ:LEND). When they asked if this might be a good time to buy more shares, I rescinded my original advice and suggested they might consider selling. Fortunately for both of us, they stuck with their guns and the stock has returned to pre-subprime-crisis levels.

In the past year alone, my personal holdings of miner Coeur d'Alene have seen precipitous falls. I've lost about 34% on that stock. There's blood in the streets of the silver industry, and much of it, without a doubt, is mine. 

Take advantage of a great opportunity
But Coeur d'Alene is still a relatively strong operator with a decent future, which is very difficult to see through the fog of a poor earnings report or some other negative event. And today, even though I've gotten hammered on the stock, I'm convinced that selling out now would be a shortsighted action that would cost me serious money. Why? Because the fundamentals haven't changed.

Human instinct tells us not to stay aboard a sinking ship. It's an innate survival tactic that affects the way we invest. In many cases, this instinct alerts us to situations that would otherwise doom our portfolio. When I see accounting malfeasance or strong insider selling going on, this instinct kicks in and I get scared. But when I see a terrorized market that's unjustifiably killing great companies, including my own, I get excited.

Seeing red on your portfolio is nothing to be afraid of. Admittedly, too much red is just flat-out unacceptable, but sometimes it's opportunity staring you in the face.

Warning and opportunity
While Rothschild's quote is a bit visceral, it's right on the money. At our own Motley Fool Hidden Gems service, which looks for stocks that fly too low for most investors' radar, we have some amazing companies that have seen some "bloody days" of late. For instance, consumer product maker Middleby (NASDAQ:MIDD) has seen a 13% haircut in the past month alone. Yet it's a solid company with growth prospects, good management, and a superior product catalog. The fall just means it's gotten cheaper. The same can be said for another Hidden Gems recommendation, First Marblehead (NYSE:FMD), which has shed about 30% in 2007.

So when it comes to your own portfolio, I advise you to think twice before selling that dog that's lost money. If your original analysis holds, it may actually be time to hold steady -- or buy more. And if you're looking for some fantastic stocks to buy, many of which are off recent highs, I encourage you to look at our Hidden Gems small-cap investing service. A risk-free 30-day trial is yours to enjoy.

This article was originally published on March 28, 2007. It has been updated.

Fool analyst Nick Kapur owns shares of Coeur d'Alene. Washington Mutual is an Income Investor recommendation. Middleby and First Marblehead are Hidden Gems picks. The Fool has a disclosure policy.