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Pump and dumps are a sad part of the financial world. They exist in all markets and can cause tremendous heartache for its victims.
Those that can spot a pump and dump, and know how they work, can easily avoid them. Skilled traders can profit off of them as well.
The truth is, stocks are not the only thing getting pumped and dumped. It’s a popular scam within the world of crypto and other financial markets as well.
What is a Pump and Dump?
Scammers will hype and pump the stock to artificially raise the volume and price. The fraudsters already own the stock and unload once it’s been pumped.
That’s the dump. Investors distribute their holdings onto retail shareholders who believed the hype. By then, most retail has already bought the peak.
The dump causes victims to sell for a significant loss or bag hold for all eternity.
Once the stock has crashed, people realize how overvalued and overhyped the company was. This type of manipulation is illegal, but it still happens quite often. Pump and dumps are most common with penny stocks and cryptocurrency.
Differences Between Other Similar Schemes
A pump and dump is similar to an economic bubble and Ponzi scheme. However, there are some key differences you should know.
- Economic bubbles are not purposely hyped using illegal methods.
- Ponzi schemes are more complex and usually involve privately traded investments.
- Ponzi schemes can evolve from legitimate investments. Pump and dumps are a premeditated scam from the beginning.
Infamous Pump and Dumps
These are some of the most notorious examples of pump and dumps throughout history. There are thousands of more examples to be found out there. However, these 4 are particularly noteworthy.
The “Wolf of Wallstreet” is based on a true story. Jordan Belfort scammed investors for millions using pump and dump tactics.
His penny-stock brokerage Stratton Oakmont would illegally pump stock prices and then dump them on investors. Jordan spent almost two years in prison and had to pay back over $100 million for his crimes.
Leaders of the energy company Enron created a sophisticated pump and dump scheme before the company’s collapse. Enron’s earnings were falsified, their accounting method was fraudulent, and many people were involved in the scam.
Wall Street analysts were pumping the stock even when signs of fraud began to appear. The dump was one of the most brutal in history. The share price went from $90 to eventually $0.
Langbar International was a fraudulent company listed on the London Stock Exchange that shared a similar fate to Enron. The company was listed on the Alternative Investment Market. The business model involved buying distressed companies, turning them around, and selling them for a profit.
The problem was the largest shareholders failed to pay for their shares. And the company made extravagant lies about how well it was doing. The stock price climbed with the fraudulent claims that the business was profitable. Eventually, the truth got out, and it all collapsed.
The Radio Pool (RCA)
This example takes us back to the late 1920s or the “Jazz Age.” RCA was a boiling hot tech stock at the time, and a group of investors turned it into a pump and dump.
The scamming investors were known as the “Radio Pool.” They bought and sold the stock to themselves to inflate the price. It worked very well. RCA stock rose above $500 in the year 1928. Of course, it crashed along with the market and traded under $10 a share.
How to Identify a Pump and Dump
Penny stocks are the most common securities for pump and dumps, mostly because they have a low float.
A stock with a low float means there are fewer shares available to trade. This allows whale investors to buy up shares and increase the stock price.
You can identify a pump and dump by looking for these signs:
- Lack of transparency from owners and company financial statements.
- Too good to be true valuations and promises.
- An eruption of high trading volume based on unfounded hype.
- Reverse takeovers or mergers. This is when a private company becomes publicly traded by merging with a public company.
- Shady management and suspicious insider trading.
If you find a soaring stock with a low float with two or more signs on this list–it’s most likely a pump and dump.
How to Avoid Investing in Them
An investor can easily avoid pump and dumps by doing three things:
- Performing due diligence before investing in any company.
- Not falling prey to FOMO. (fear of missing out)
- Avoiding penny stocks altogether.
Most victims of pump and dumps are inexperienced investors or people looking to get rich quick.
Take investing seriously and do your research. Don’t let FOMO overtake your investing decisions. By doing this, you’re almost guaranteed never to become a victim of a pump and dump.
How to Trade Them
I do not trade penny stocks or look for pump and dumps. I do not recommend others to do so either. With that said, there are ways to trade and profit off them.
To trade a pump and dump, you want to go long during the run-up and short during the dump. The hard part is knowing when the pump is going to begin and end.
You will have to decide if the pump is just starting or about to fizzle. This depends on the type of security and the news that is causing the pump.
If the story is big enough, it may have the legs to run for a while. If the information is obviously fraudulent or desperate, the pump will likely be short-lived.
Trading pump and dumps is extremely speculative and involves a high amount of risk. Everyone thinks they can sell before a crash until they get stuck with a bag.
When it comes to pump and dumps, most people think of penny stocks and now crypto.
The scam is indeed mostly prevalent in these types of securities. However, that doesn’t mean other investments are excluded from becoming a pump and dump.
All it takes is some deceitful investors paired with some big news or false claims.
Pump and dumps can happen fast and aren’t always easily identified until the price has collapsed. Don’t let potential profits and euphoria sway you into becoming a victim.