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Schwab and Ameritrade in the spotlight: Are broker stocks worth buying?

Charles Schwab and TD Ameritrade are in the spotlight for a potential merger, and their shares are soaring. Those are great brokerage firms, but prudent investors ought to ask the most important question before discussing an investment.

Let’s explore the issue starting with a chart to develop the background.

Please click here for an annotated chart of Schwab SCHW, +0.35% stock.

Read:Wall Street is in the ‘early innings’ of discount-brokerage mergers, experts say

Note the following:

• Schwab stock has significantly underperformed the Dow Jones Industrial Average DJIA, +0.39% and the S&P 500 SPX, +0.22%. Other brokers, including Ameritrade AMTD, -0.52%, E*TRADE ETFC, +1.92% and Interactive Brokers IBKR, +2.37%, are also underperforming, but that may reverse itself.

• The chart shows that Schwab stock has been in a downtrend.

• The chart shows the gap down on the news of zero commissions, a potential threat to profits.

• The chart shows the breakout above the trend line with a gap up on news related to Ameritrade.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

The most important question

The danger in zero commissions is that this may lead to overtrading. Overtrading is a common affliction for many traders. They believe that the more they trade, the more money they will make. Unless you are a professional trader, for most people this is a wrong belief. Overtrading often leads to losses.

Here is the most important question to ask yourself: “Is your objective to generate maximum risk-adjusted returns or is your objective to do the most number of trades?”

Investing in broker stocks

We give signals in different time frames ranging from very long term to very short term.

The news always provides trading opportunities. In the pre-market, the momo (momentum) crowd ran up Schwab to a level that was difficult to justify. The Arora Report gave a signal to short-sell Schwab at $51.70 in the pre-market and a target of $47 to $48.51. We typically give targets and stops in advance at the same time the entry signal is given. Subsequently, Schwab stock fell to $47.52, profitably completing this very short-term trade.

Schwab may become a “buy” for the long term, but, as of this writing, our system has not given such a signal. When we give a buy signal, we will give a buy zone, stop zone and target zone.

For the medium term, we have given a buy zone for E*TRADE. The expectation was that E*TRADE would be bought by, perhaps, Ameritrade. Now E*TRADE stock has fallen because the buyout premium has come out of the stock. Isn’t it reasonable to think that the new landscape may force E*TRADE to consider selling itself? Will someone like J.P. Morgan JPM, +0.66% be interested in buying E*TRADE? For this reason, E*TRADE becomes a buy for aggressive investors in the Arora buy zone.

Interactive Brokers has a unique opportunity to further differentiate itself from its competitors. If Interactive Brokers starts going on this path, The Arora Report may also issue a buy signal on the company.

There are implications for full-service firms, and there may be new investment and trading opportunities for them.

Short-term trading opportunities may occur both from the long side and the short side.

One of The Arora Report portfolios also has a long-term position in broker-dealers and securities-exchange ETF IAI, +0.65%.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at [email protected].