Pump and Dump Stocks
Pump and dump is a fraudulent, often illegal scheme of creating an exaggerated, misleading, and false hype around a stock. Such hype artificially inflates the price of a stock for a short period. Those who hold a position in the company’s stock, the ones who perpetrated the scheme, end up selling their positions at a high price, often enjoying hefty profits.
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Pump and dump stocks has been prevalent for ages; however, with ever-developing technology, the practice has become more common and frequent. The perpetrators create false positive recommendations about a stock online and bask in the glory of the thus-created high prices. Basically, they shift the balance between supply and demand of the shares. Once the sellers sell their stock, the price drops drastically, and new traders end up losing a lot of money. Mostly, the micro stocks and small-cap stocks, also known as penny-stocks, are affected by such manipulation.
Types of Pump and Dump
Pump and dump can be categorized into two types:
- One person pump and dump: One person pump and dump involves only one person buying or selling a stock excessively. The intention behind such cases is often not to scam or defraud, but personal decision and benefit. Therefore, a single person’s pump and dump is sometimes legitimate.
- Multi-player pump and dump: On the other hand, when many people are encouraged to buy a particular stock based on false rumors and hoax endorsement, it shifts the entire balance of the market. The price of the stock rises exponentially and disrupts the market behavior. Then, when the same stock is sold in bulk by culprits, the price falls dramatically and causes a massive loss to the buyers. This form of pump and dump is illegal as it is considered securities fraud.
However, pump and dump schemes can only turn out to be successful with micro or small-cap unregulated stocks. Authorities like the SEC, FINRA, and ESMA regulate most stock trading on US or European stock markets. Most of these companies file with regulators, and any release can be cross-checked with the filings to ensure the credibility.
Pump and Dump Penny Stocks
As mentioned above, pump and dump scams become easier when stocks are unregulated by authorities and trade in low volumes. This is precisely the case with penny stocks, making them highly vulnerable to such schemes.
The most significant reason for penny stocks getting the most affected by rogue players is their volume. They become very easy to manipulate due to their small float. Since the volume is low, it does not take a lot of buyers to manipulate the price or push it higher. At the same time, penny stocks are highly illiquid, and any changes in the volume cause sharp price movements.
Therefore, it is always advisable to not trade penny stocks as they are easier to manipulate. It takes only a few people to affect the price movement and traders end up losing a lot of money.
Additionally, traders and investors must remember that if any information is too good to be true, it probably is. A sudden stock tip through an email or phone call stating that a particular penny stock is about to shoot, must be looked at with caution.
Recent Pump and Dump Penny Stocks
Penny stocks pump and dump scams are widespread. Between 2012 and 2014, about 1,300 stocks were suspended from trading for fraud investigations.
One of the largest pump and dump scams is associated with the site awesomepennystocks.com. The founder, John Babikian, used to acquire a large number of shares in a penny stock and then promote it aggressively through multiple websites. After the stock price rose drastically, he would sell his stake and make millions in profits.
The most recent pump and dump penny stock is China Infrastructure (CHNC). Almost every day, the stock gets loaded and unloaded by unknown traders, causing substantial price movements.
Is There A Solution?
Traders need to be vigilant and cautious about unsolicited notices and endorsements regarding specific stocks. If a newsletter mentions only the hype and nothing about the risks, you should stay away from the stock.
Along with being cautious, traders can take the opportunity of trading through funded accounts. Such accounts protect investors and their money. Tradenet offers one of the leading funded education account programs.
Aspiring traders can enroll themselves to various education packages of Tradenet. These packages not only prepare new traders through trading courses and training videos but also make students who clear the entrance exam eligible to apply for a funded trading account,which is provided by a third party investment firm, of up to $240,000 with up to 85% profit split.