Thursday, July 18, 2024 9:54:12 PM
Here, we take a closer look at how pump-and-dump schemes work and how to avoid them.
KEY TAKEAWAYS
Pump-and-dump is a scheme that attempts to boost the price of a stock through recommendations based on false, misleading, or greatly exaggerated statements.
The favored medium of communication for traders involved in pump-and-dump is social media platforms or anonymized messaging apps like Telegram and Discord.
Promoters of the scheme will then begin to coordinate rumors, misinformation, or hype in order to artificially increase interest in the security, driving up its price.
Then, once the price of the stock has been increased sufficiently by unsuspecting marks, the promoters then sell the stock at high prices.
The Basics of a Pump-and-Dump
Pump-and-dump schemes were traditionally done through cold calling. But with the advent of the internet, this illegal practice has become even more prevalent. Fraudsters post messages online enticing investors to buy a stock quickly, with claims to have inside information that some development will lead to an upswing in the share's price. Once buyers jump in, the perpetrators sell their shares, causing the price to drop dramatically. New investors then lose their money.
These schemes usually target micro- and small-cap stocks, as they are the easiest to manipulate.
Due to the small float of these types of stocks, it does not take a lot of new buyers to push a stock higher.
The stock is usually promoted as a "hot tip" or "the next big thing" with details of an upcoming news announcement that will "send the stock through the roof". The details of each individual pump-and-dump scam tend to be different but the scheme always boils down to a basic principle: shifting supply and demand. Pump-and-dump scams tend to only work on small and micro-cap stocks that are traded over the counter.
These companies tend to be highly illiquid and can have sharp price movements when volume increases. The group behind the scam increases the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has been formulated, the group will sell its position to make a large short-term gain.
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