Market Markdowns Provide Shot At Cashing In or Cashing Out

January 26, 2005

This year has certainly gotten off to a rocky start, what with the Dow Jones Industrial Average down 3.5% and the Nasdaq off 7.6% as of Monday's close. But just as shoppers often get excited over sudden markdowns, I have learned to view market corrections as genuine opportunities. If the market never declined, there would be no risk, lower returns and fewer opportunities to outperform the market averages. When the market drops, my investing pulse starts to quicken.

And even during market slumps, there can be significant bright spots. Just this week, Corinthian Colleges announced that the Securities and Exchange Commission had cleared it of any wrongdoing in its statements to investors and its handling of an inquiry into student-loan practices. I highlighted Corinthian in my column of Sept. 7, citing it as one of those special situations that offer investors rich opportunities. As I noted then, these stocks can help offset broader volatility and cushion a market decline.

As I wrote before, I bought long-term call options on Corinthian shares, which went as low as $10 on news of the SEC inquiry. The shares had recovered some of their losses by the time the company released this week's good news, but shares still jumped more than 10% on Monday, to more than $17. In addition to the handsome gain in my portfolio, I'm also pleased that in this era of rampant corporate misconduct, my instincts that Corinthian's management was trustworthy proved vindicated.

Because the Corinthian Colleges special situation is now at an end, it is time to cash in all or part of the gains. Even so, Corinthian shares are nowhere near their pre-investigation high of $36. So I plan to keep half the calls and sell the others.

There is plenty I can do with the proceeds. With the Nasdaq hovering just above 2000, this is a good time to review my overall strategy of buying and selling. I try to implement a simple strategy of buying lower and selling higher. Generally, I aim to buy when stocks fall 10% from their most recent high, and I continue buying on further drops of 10%. I generally sell when stocks have rallied 25% from their most recent low, and sell more when they rise in further increments of 25%. I use the more volatile Nasdaq as my benchmark, but any broad index will do.

The Nasdaq reached its 52-week high close of 2178 on Dec. 30. Since I do the math in my head, I'll just round that off to 2200, which means a buying opportunity would present itself at 1980.

Besides the numbers, I also like to consider other factors, such as the overall mood in the market. Last August, the last time I signaled a buying opportunity, the mood was pretty grim. Investors were bidding up bonds as though a recession were just around the corner, and there was also palpable anxiety about the upcoming presidential election. Paradoxically, I find that this kind of pessimism often marks a significant buying opportunity.

I detect no such sentiment at the moment. The economy seems to be perking along, even though oil prices have again been creeping up to the $50 level. Corporate earnings have been solid if not spectacular, and corporate spending is showing signs of a revival. All I'm really hearing is that stocks "have gotten ahead of themselves" or the market is "fully valued." In this environment, I wouldn't be surprised to see the Nasdaq hit my 1980 target, so I'm inclined to wait.

Still, with those Corinthian profits burning a hole in my pocket, I might go ahead and buy more of one stock that has just experienced drastic markdowns: eBay. After reporting earnings last week that were slightly below forecasts, eBay dropped nearly 20%. It can't keep growing at a stratospheric rate every quarter, of course, but it is transforming the nature of world commerce, and it's a natural monopoly. If I owned only one Internet stock, eBay would be it.

James B. Stewart is an editor at large at SmartMoney magazine and a contributing editor at He may have positions in the stocks he writes about. To read past Common Sense columns, visit