How does a Pump and Dump Scheme Works with Penny Stocks? 

Trading concepts

Pump & Dump

Pump and dump penny stocks scheme is a form of fraud you experience in investment and securities. Fraudsters make a lot of money using this fraudulent scheme by selling penny stocks at inflated prices. 

Do you want to know how a pump and dump penny stocks scheme works? Then you are on the right platform at the right time. In today’s post, we are going to explain how this scheme works on penny stocks and how can you avoid it? Let’s dive deep and find out. 

Pump and dump penny stocks scheme

In simplest terms, a pump and dump penny stocks scheme is a fraudulent activity. Scammers plan this activity to inflate the prices of penny stocks and sell their shares at a peak price level. This investment and securities fraud involves delivering exaggerated, false, and misleading information about a company. So, an investment opportunity is created by scammers who attempt to generate substantial profits by selling their stocks at inflated prices. As a result, people investing in pump and dump penny stocks suffer huge losses. Why so? Because fraudsters sell their stocks at high prices and as a result of that, prices of those penny stocks suddenly fall.

How does a pump and dump penny stocks scheme work?

As we have already discussed, scammers increase the prices of penny stocks by spreading false and misleading information. How is this exaggerated information provided and why do people believe it? There are multiple ways that scammers use to spread misleading information. Moreover, they do it in such a way that most investors fail to understand what is happening. 

Firstly, the pump and dump penny stocks scheme begins with a glowing press release. Usually, it is on the financial health of a company. It may also be about some new innovative product, a huge contract, or something else that will substantially enhance the growth chances of that company. So, common investors begin to consider that company a good investment opportunity. This first step lays the foundation for a huge scam.

Secondly, scammers bring an allegedly unbiased newsletter to brand that company as the hottest stock. They may also capitalize on forums such as financial chat rooms and bulletin board postings to create further hype. Their messages urge investors to invest in that company before the price shoots up. In some cases, you may even hear about such penny stocks on sponsored radio or television programs. 

That means, the pump and dump penny stocks scheme is implemented in a very organized way. As a result, most investors, usually beginners, do not suspect fraud or scams. They begin to consider it a valid and profitable trading opportunity. So, heavy investment causes the price to skyrocket. This is how scammers “pump” the price. When the price reaches the highest possible level, fraudsters begin selling their stocks which brings prices down to the surface. That said, the dump causes huge, if not total, losses for innocent investors. 

Which penny stocks are more prone to pump and dump schemes?

Is the implementation of the pump and dump scheme possible for companies offering a lot of information to the public? No, it isn’t possible. When there is a lot of information to analyze, the pump and dump scheme is impossible to implement. 

On the flip side, if there is no information available about a company, it is easier to do the fraud. Therefore, fraudsters frequently use this plot with penny stocks. It is easier to manipulate the stock prices of small, thinly traded companies. Why so? Because little or no information is available about that company. So, no one can analyze the company or check the validity of the news.

Types of pump and dump penny stocks scheme

There are different types of pump and dump penny stock schemes that scammers utilize. However, the most common types are the following. 

1. Classic

The classic pump and dump penny stocks scheme is the most common one. It involves any type of manipulation scammers attempt regarding a company and its stock price. For example, they may spread misleading information about a company, fake news releases, and so on. Scammers may also utilize the services of dishonest brokers or stock promoters to attract the attention of potential investors. In short, such activities are more than enough to boost the stock price of a company. 

2. Boiler room

A boiler room scheme refers to a pump and dump scheme whereby a boiler room (a small brokerage firm) employs numerous dishonest brokers. These brokers trick innocent investors and sell stocks of questionable companies to them. Brokers sell stocks of a penny stock that the boiler room buys. When a lot of brokers work in collaboration, the stock price of a company is significantly enhanced. Eventually, the boiler room firm sells stocks of that company at huge profits.

3. Wrong number

The wrong number is another scheme that you may also encounter, especially in recent years. It involves sending voicemails to potential investors. These voicemails discuss a hot investment tip. In addition, fraudsters also make people believe that voicemail was accidentally sent to their phones. However, it is a deliberate action to attract the attention of potential investors. 

How to avoid pump and dump schemes?

A pump and dump penny stocks scheme may cause substantial losses for you. Therefore it is important to learn about different ways to avoid such schemes. Here are some unique and useful tips to avoid suffering losses because of such fraudulent activities. 

1. Don’t accept unsolicited advice

Laws all across the globe require legitimate and registered financial advisors to recommend investment opportunities. They have a legal obligation to you. Contrarily, anonymous and unregistered advisors seek to fill their own pockets. Additionally, they don’t have any legal obligation to you. Such advisors may be touts who get paid for selling questionable stocks to investors. Therefore, it is better to avoid such advisors. It is the best option not only to avoid the pump and dump scheme but for overall investing in general.

2. Don’t believe in unsolicited emails and voicemails

As you already know, receiving unsolicited emails or voicemails from strangers also leads you to fall prey to fraudulent schemes. You may receive an email enticing you to invest in a particular penny stock. If it happens, you should choose to discord that message for your own good. If you believe that information, you might very well be on the receiving end of a scam. Therefore, it is important not to believe in unsolicited emails or voicemails. 

3. Do your own research

It is also true that the price of a penny stock may rise substantially in some cases. In such cases, it is hard to neglect the urge of making quick money. However, it is important not to act impulsively. You should do your own research before investing. For example, you can analyze the financial information of that company before investing. Otherwise, you may end up buying penny stocks at inflated prices.

4. Avoid acting on social media and message board promotions

Social media and message boards have made it easier for scammers to reach millions of people in a very short time. These modern platforms have already exhibited their power. For example, they contributed to skyrocketing prices of stocks like AMC Entertainment and GameStop. People want to make money and they utilize different schemes for it. They may even work in collaboration to push the prices of a stock higher to sell their shares at their peak. Therefore, it is important not to act impulsively on suggestions of any social media group or message board. 

The wrap-up

The pump and dump penny stocks scheme is a fraudulent activity that pushes the prices of penny stocks to explode. When prices substantially increase, scammers suddenly sell their stocks at peaks and as a result, stock prices begin to decline suddenly. This is how a pump and dump scheme works. Scammers pump prices of penny stocks by using different schemes. For example, they may deliver fake and misleading information about the finances of a company to boost stock prices. They do so to push prices higher and sell their shares at inflated prices. 

That said, such schemes cause significant losses for innocent investors who buy stocks during pumps. Therefore, it is important to know all about pump and dump penny stocks and how to avoid such frauds. 

Russell Crane

Russell Crane

Russell is an Algorithmic & Technical Analyst Trader @ PatternsWizard.
His passion is to share his knowledge about TA, patterns & more. Why hope for your trading to work when you can precisely know the performance stat of every pattern?

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