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How Pump and Dump Investing Schemes Work

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What are pump and dump investing schemes?

You don’t have to watch movies like “The Wolf of Wall Street” or “Boiler Room” to know what pump and dump scheme is about.  Brokers pitch penny stocks to customers in high volume despite its questionable returns.  Once the buyers dry up, the firm ditches its shares for a big profit and drives stock prices down. That results in huge losses for customers and is, unsurprisingly, illegal.

What Does Pump and Dump Mean?

Brokers fraudulently pump the price of a stock by providing misleading or false statements about the company. That creates demand, which increases the price of shares.

Those fraudulent brokers contact customers through e-mail and social media channels. They’ll make outlandish claims about stock performance in an attempt to get investors to spend your money on their stock. They might claim you’ll get rich quick and that the stock is primed for big returns.

Once enough people have bought into the scheme, that’s when the dump happens. Investors or company insiders sell their own holdings of a stock, dumping shares into the market and causing the stock to plummet. When none of the brokers’ promises about those stocks turn out to be true, investors lose their money.

Pump and dump is only a low-risk proposition for the scammers. Penny stocks and other small- to micro-cap stocks are cheap. Because they’re offered in small pools, they’re also easy to manipulate. A scammer doesn’t usually have to get many buyers on board to inflate the price of such shares.

Online Pump and Dump

Technological advances have only made pump and dump schemes easier to execute. Anyone with access to an online trading account and a pool of willing buyers can quickly manipulate a stock. Buying up a lot of a stock that sells at low volume starts the process by pumping up the price.

Once the share price in inflated, a scammer can show other investors that performance. If those investors are convinced the stock is hot, they’ll buy in and pump up the price even further. When investment tails off, the scammer can then dump the shares for a huge profit.

How to Spot These Scams

What are pump and dump investing schemes?

The Financial Industry Regulatory Authority (FINRA) notes that pump and dump schemes don’t have to be widespread to pay off. Inflated shares of Jammin’ Java, a company that licensed Bob Marley’s image to sell coffee, took in $78 million after a former CEO and his associates allegedly dumped 45 million shares into the market and crashed prices. If you’re unsure how to know if a promotion is real or not, you’ll have to take a few factors into account. 

Spot the source

Where are you getting this information? If you receive newsletters or emails from sources you’ve never seen before, take caution. Also be wary of e-mails or alerts from companies that have similar names or logos to ones you’re familiar with. If they seem slightly off or cheaply rendered, you may want to steer clear.

Note the frequency

Unknown or spam e-mails can be bad enough on their own. If you’re getting several within a day or two, that may be a warning? That flood of communication is likely an attempt to inundate you with the same message and convince you to make a move or purchase.

Check them out

If something looks bad and smells bad, it’s probably bad. Do a quick online search of the company to see who they are and what they do. See if there are any convictions or indictments among the people in charge, or even those who are promoting the company on their behalf.

Look at the stock

See what price the stock has been trading at throughout its history. Shares in a pump and dumps are usually priced low and have minimal activity. And that activity usually isn’t on regular stock exchanges like the New York Stock Exchange (NYSE) or the NASDAQ. If shares aren’t on a national securities exchange, that can be a red flag.

Dig into SEC filings

You may want to look into the company’s public reports filed to the SEC. If the company is trading in an over-the-counter market and not on a normal stock exchange, they are not required to disclose those filings. You should be cautious of any missing company reports.

If you feel you’ve been targeted by a scam you can report possible fraud to the SEC. You can also report a problem to the SEC if you feel you’ve been a victim of an investment fraud.

Bottom Line

Getting duped by an investment scheme isn’t fun. But you can protect yourself. By knowing how to spot pump-and-dump fraudsters and then how to take action, you’re not only helping your investments, but other investors as well.

If you’ve done your homework on an investment and are still concerned about it being a pump and dump, you may want to consult a professional. A financial advisor may be able to help you sort sound investments from scams.

Investing Tips

What are pump and dump investing schemes?

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The post How Pump and Dump Investing Schemes Work appeared first on SmartAsset Blog.

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