This Charles Schwab Gamble Just Sent Online Broker Stocks Plummeting

Investors Sold off Brokerage Stocks on Tuesday. Is an Immediate Bounce-back Coming?

Charles Schwab Corp. (SCHW) announced plans to eliminate its $4.95 commissions on all stock, ETF and options trades on Tuesday. The idea is to “make investing easier and more affordable for everyone.” Nice gesture, right? Not to the cold, dead hearts of veteran Wall Street traders—shares of Charles Schwab and other online broker stocks sank like a rock in response to the announcement.

Here’s how four of the major online broker stocks, including SCHW, had fared through the first couple hours of Tuesday trading (and as of this writing):

Online broker stocks got crushed on Tuesday.Yikes! Yep you’re reading that right: TD Ameritrade (AMTD) and E-Trade (ETFC) were down an average of roughly 20% in early Tuesday trading—and those two companies aren’t even the ones dropping their brokerage fees!

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Why did investors respond so negatively to Schwab’s commission-elimination, which won’t even take effect until next Monday, October 7? Most likely today’s decision to eliminate these commissions is further proof that these brokerage firms are in an all out war amongst each other, and are aggressively looking for creative ways to separate themselves from the pack.

And while paying zero commissions sounds like a huge win for the investor, there’s a catch…and it has to do with the word “fill.”

No Commissions = Less Price Control

When you pay a commission to buy a stock through your online broker, you can select the share price at which you want your order filled. In other words, you have the luxury of choosing the best fill price.

However, with commission-free brokerages like Robinhood, to recoup the money they’re losing from charging you a trading fee your online broker sells your order to the highest bidder instead of giving you the fill of your choosing. For instance, if the market on a stock is $9.98 – $10.00, and it’s possible that you could buy the stock at $9.99, you’ll instead get it at closer to $10.00 per share—a small difference, but one that adds up if you’re buying, say, 1,000 shares.

These online brokers are getting up to $0.003/share in exchange for your order. So if a trader buys 2,000 shares, that’s $6 extra your brokerage firm gets – more than the $4.95 commission Charles Schwab currently (though not for long) charges on each trade.

Jacob Mintz, chief analyst of our Cabot Options Trader and Cabot Options Trader Pro advisories, is a former market maker himself, having worked on the trading floor of the Chicago Board of Options Exchange for nearly a decade prior to joining Cabot Wealth. So I asked for his take on Schwab’s controversial switch to zero commissions.

“Basically, it’s a gateway drug,” he said, “a marketing ploy to get people to bring their money to these sites. But the thing is, with these zero commissions you are giving up a good fill, potentially.”

Hence, the backlash—on not just SCHW, but all major online broker stocks, at least for one day.

Buy the Bad News on Online Broker Stocks

Chances are this is classic Wall Street overreaction, and all these brokerage stocks will bounce back swiftly and completely in the coming days. In fact, I would bet on it—in which case I would buy the bad news (as we often recommend) by picking which online broker stock you like best, and pouncing before they have a chance to recover from Tuesday’s bloodbath.

Six months from now, we’ll see how the decision to go commission-free has affected Charles Schwab’s business and, more importantly, its stock. And we’ll see if other online brokers follow suit in eliminating their fees.

One thing’s for sure: Wall Street isn’t a fan of it. And if you’re someone who likes to buy a lot of shares of the companies you’re investing in, perhaps you shouldn’t be either.

Chris Preston

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Investment analyst and Chief Analyst of Cabot Wealth Daily, Chris Preston brings you all the latest from the investing world. Sign up to get updates and breaking news delivered FREE to your inbox. Get unlimited access to our library of complimentary investing reports.

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