What is a pump and dump?
Pump-and-dump is a form of fraud that encourages investors to buy shares in a company to increase the cost of the shares artificially. It can be used to boost the price of a stock through recommendations based on false or misleading information. Pump-and-dump traders use social media platforms or messaging apps to start rumours, spread misinformation, or hype to increase interest in the security to increase its price. When the price of the stock has been raised, the promoters sell the stock at high prices.
How are pump and dump done?
Pump and dump were traditionally done through cold calling. With new technologies and the availability of internet, it has become more accessible. There are two parts to this scheme:
Pump: Fraudsters post messages online that encourages investors to buy a stock quickly by claiming they have access to confidential data.
Dump: Once the prices increase, the perpetrators sell their shares at a high rate. New investors then lose their money if the prices drop dramatically after the traders sell their shares.
Pump and dump schemes mostly target small-cap stocks, as they can be easily manipulated. Only a few shares of this type float in the market and sold over the counter, only a few new buyers are needed to push a stock price. This new inflow of buyers causes stock prices to increase rapidly. Once the price rises, the traders sell their shares to get a sizeable short-term gain. The details of each pump and dump scam can be different, but the scheme has the same basic principle: changing supply and demand of a stock.
Online Pump and Dump
Pump and dump scheme can be carried out by anyone who has access to an online trading account. The trade buys heavily into a stock that has a lower trading volume. This can pump up the price of the share. This price increase can entice other investors to buy these shares, and the price even higher. At any point, the trader dumps his shares for a significant profit.
What are the types of Pump and Dump Schemes?
The different pump and dump schemes that may be used by fraudsters are:
1. Classic pump and dump scheme
This scheme involves the manipulation of information regarding a company and its stocks via telephone, fake news releases, and distribution of some “inside” information that can boost the stock price.
2. Boiler room
A small brokerage firm employs several brokers that use dishonest sales practices to sell investments to investors. The brokers sell stocks by cold calling. They sell as many shares as possible required to boost the price. Once the stock price rises, the brokerage firm sells its portion of the stock for a hefty profit.
3. “Wrong number” scheme
You may receive voicemails with an insider investment. The fraudsters try to make it look like voicemail was accidentally sent to you. It is a targeted action to attract the attention of potential investors to a particular stock and boost the demand for this stock.
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