Pump And Dump Scheme: Strategies to Protect Your Investment
Pump And Dump Schemes have been around for a long time and have claimed countless unsuspecting victims. In this article, we will tell you all about this dangerous scam. You will learn how a Pump And Dump Scheme works, types, and most importantly how to spot them in time and avoid them.
Only by thoroughly understanding these schemes can you save your hard-earned money and make sound investing decisions. Let’s get right to it!
What Is Pump And Dump?
People who are in the finance industry already know what these schemes are, but here’s the rundown for all the others who do not.
A Pump And Dump Scam is an illegal scheme to inflate the price of stocks or securities by spreading false information about their values. When the stock price rises, the scammers sell their shares leaving them with a heap of cash and other investors with significant losses.
This scam was always popular but with the advent of the internet, it has become even more widespread. There are more ways for scammers to pump the stock and more ways for potential investors to find out about it.
Understanding the Mechanics of a Pump And Dump Scheme
Although it might seem complicated, understanding pump and dump schemes is not that hard. There are two stages of the scheme and as the name suggests, those are the pump and the dump stage. We will illustrate this in the following example.
So, imagine we have John and Michael and they buy stock in a small company. They then try to convince other people to invest in it by making false claims and aggressively advertising it wherever they can. This is the pump phase and the goal here is to boost the stock price as high as you can. The higher the price, the more money our two protagonists will get when they sell their shares.
Then comes the dump stage and this is where things get ugly. So, the stock price of John’s and Michael’s company skyrocketed and many people invested in it. The problem is the company is vastly overvalued, but the investors do not know that.
John and Michael sell or ‘dump’ their stocks, earning a fortune in the process. On the other hand, other investors are not that lucky. After our protagonists sell their shares, the price drops massively and all the investors are left with major losses.
The Birth of a Scheme – How Pumps are Initiated
As mentioned the key concept in these schemes is false advertising. This used to be done by cold calling but social media has exasperated the problem immensely. Nowadays, scammers spread information on Facebook, Instagram, Telegram, Discord, and other platforms.
Additionally, they can hire influencers to do that for them. They already have a large following and social media celebrities have a strong influence on their audience. By telling the fans about this amazing new company they are investing in, influencers can lure them into a pump-and-dump scheme.
The Downfall – The Reality of the Dump
The dump stage can be devastating for some. There are many cases where people invested their last penny to get enough money in return for a loved one’s surgery or other life-or-death situations. Losing all that money leaves some investors in financial dire straits and shows how dangerous a pump and dump fraud can be.
Types of Pump and Dump Schemes
There are several types of pump-and-dump schemes:
This is the original type of pump and dump scheme and it involves spreading false information about a stock value through as many channels as possible. This includes contacting people on social media, calling them, releasing fake news about the company, etc.
This scheme is a modern one, especially gaining prominence with the rise of cryptocurrencies and trading. A boiler room is a small brokerage where many scammers work on convincing you to buy a particular stock.
The method in widespread use is cold calling and they employ many shady tactics to sell you their pitch. Making false promises of immense riches is the most common lie, so be on the lookout for that.
“Wrong Number” Scheme
This one is pretty self-explanatory. Scammers leave you a voicemail with a tip to invest in a company and make a fortune. They want you to think the message was left on the wrong number (yours) making the tip seem more real.
Spotting a Pump And Dump Scheme – Red Flags to Watch Out For
Sometimes pump and dump fraud might be difficult to spot, but there are some general signs you can look for.
Firstly, look for rapid price increases. Follow a company’s stock for some time and if you see that the price jumped from $0.5 to $2 in one week, you can suspect that some shady business is going on. Stock prices do not jump so rapidly in regular circumstances, so that is a valid indicator of a pump and dump scam.
Furthermore, online hype and the pressure to invest quickly can also indicate scams. In some cases, online hype is a legit thing, but if there is a sudden interest in a company that no one really heard of until that point, you have every reason to think something is not right.
How To Avoid Pump And Dump Schemes
The first thing we advise is to be skeptical about ‘too good to be true’ investment opportunities. If people promise you extraordinary returns with minimal risk, it is probably a scam.
Another rule of thumb is to do your due diligence and thoroughly research every company you want to invest in. See the history of their stock, how big they are, and if they are objectively worth the price of their current stock.
The Bottom Line
Pump and dump schemes have been here for a long time but that does not make them less dangerous. They can do even more harm now when scammers can use social media to support their false advertising.
However, you should not be afraid. We have taught you how to spot a Pump And Dump Scheme and more importantly, how to avoid getting scammed. With this knowledge, you can rest assured you can see through any Pump And Dump fraud you encounter.
What is the pump and dump scheme?
A pump and dump scheme is an illegal scheme to boost the price of stocks and securities, only to sell them for big profits, while other investors experience huge losses.
Why are pump and dump schemes illegal?
They are illegal because they are manipulative practices that harm unsuspecting investors and undermine the integrity of financial markets.
What is a real-life example of a pump and dump scheme?
An example of a real-life pump and dump scheme is the Stratton Oakmont scheme. You might know it from the movie “The Wolf of Wall Street.”