Charles Schwab Corporation (SCHW) has announced that it will drop its online equity trade commissions for retail investors from $12.95/trade to $8.95/trade beginning January 19, 2010. Some other prices were also lowered, and Schwab now charges all retail clients the same fees regardless of whether the account is larger than $1 million or on the number of trades made in a year.

This move will certainly put some serious pressure on other online brokers. E*Trade (ETFC) charges $7.99-$9.99 for equity trades, and TD Ameritrade (AMTD) advertises online trades at $9.99. Schwab’s third-quarter 2009 cash balance topped $25 billion, compared with $7.5 billion for E*Trade and $6.6 billion at TD Ameritrade.

Even if Schwab loses a bit on each transaction, it can afford to do this for a fairly long time.

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Schwab pretty clearly wants to grab market share. That’s Marketing 101, especially because the company has built its reputation on being inexpensive. Even though Schwab doesn’t advertise that feature as much anymore, investors still associate the brand with low-cost fees.

A less obvious but still visible reason for the change is to drive E*Trade into Schwab’s arms. E*Trade’s market cap is just $3.3 billion, while Schwab enjoys a cap of over $22 billion. Schwab could offer as much as $8 billion for E*Trade, a premium of more than 4x E*Trade’s current share price, and still make out like a Somali pirate.

Just yesterday Raymond James downgraded Schwab from “outperform” to “market perform,” saying that Schwab’s earnings are expected to be low through 2011. One reason given for the downgrade was the current outlook for continued low interest rates. TD Ameritrade’s rating was also reduced, from “strong buy” to “outperform.”

Full-service brokers also face lower trading volume and concomitant lower revenue in the current year. Some, like Goldman Sachs (GS) and Morgan Stanley (MS), could make up the shortfall in advising and underwriting fees. Schwab’s move will have no overall effect on Goldman or Morgan Stanley, but it could be an additional irritant to revenues in the banks’ brokerage business.

The thing to watch is interest rates. If the Federal Reserve raises rates, expect trading volume to increase. If rates stay near zero, trading will remain slow. Schwab seems to be betting on the latter and that its new pricing will help garner more market share.

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