Pump and dump: What it is, why people do it, and one ugly case study

If you’re using a trading strategy that involves cheap, low float stocks such as pink sheets or penny stocks, you have to be aware of pump and dump stock schemes. 

They’ve been a problem in equity markets forever and these days, as social media and various message boards provide new pumping platforms, they have become one of the most common forms of securities fraud. Investors lose billions in such scams annually and recently the pump and dump scam has hit the cryptocurrency markets with a vengeance.

The good news is that once you know all the hallmarks of pump and dump schemes, they’re fairly easy to spot. 

What is a pump and dump?

Pump and dump is a very simple scheme, which is one reason it’s so prevalent. Perpetrators first buy a relatively large position in a cheap stock. Then, using social media, false press releases, email blasts, or good old-fashioned cold calling, the schemers pump the stock to as many traders as they can. 

After the stock price rises due to all the demand they have manufactured, they sell (dump) the stock quickly before people realize the run-up in price is baseless. When the scammers sell, the stock price plummets, leaving the new investors to absorb heavy losses, while the fraudsters are already on to touting their next stock. 

How to spot a pump and dump scheme

The easiest way to avoid losses as a result of a pump and dump is to trust your BS detector. If you don’t fall for the pumping, you’ll avoid the losses that come with the dumping. 

The pumpers, known as stock touts, aren’t known for their subtlety. They’ll guarantee success, promise enormous returns, swear on their mothers’ graves they’ll make you rich, show off pictures of their yacht—anything to get you to bite. 

The sad truth is that nothing comes that easy in the stock market. If it sounds too good to be true, it almost always is. 

In general, be wary of anyone who’s offering you stock picks, especially if the advice is of the get-rich-quick variety. Even be cautious when trusted friends pass on stock picks to you— they may have become victims of a pump and dump scheme themselves and are inadvertently taking you along for the ride. Always do your own independent research.

Another big red flag is that touts will almost always push you to move fast because they have to get rid of their position before their scheme is realized and the stock price begins to fall. These fraudsters will put enormous pressure on you to ”buy now, before it’s too late!”  

Yes, markets move quickly, but no true broker will push you to make an investment before you are ready.

Markets most impacted by pump and dump schemes

Pumping and dumping schemes are far more common in some markets than they are in others. The most commonly targeted are the pink sheet market (over the counter) and the penny stock markets. A penny stock trading off the pink sheets is a scammer’s dream.

In general, pump and dump schemes work best when the stock is cheap so that the perpetrators can take large positions without spending too much money. Penny stocks are a perfect target for this reason.

OTC markets are targeted because there are a lot of stocks that trade very few shares on a daily basis. Thinly traded stocks give scammers a much bigger bang for their buck. Convincing a few new buyers to buy Amazon stock wouldn’t make the price budge a bit, but bringing in some new investors into a stock that doesn’t have much volume will have a much higher impact. 

Another reason pump and dump schemes most often occur in the OTC markets is that companies trading over the counter don’t have nearly as many reporting requirements. That leaves investors hungry for any sort of news or financial information. A scammer can step into that vacuum with something that looks like official news and send the stock price into a frenzy.

Cryptocurrency markets have also been hit hard as of late as scammers take advantage of the fact that there are a number of investors who don’t completely understand cryptocurrency but are anxious to get in on a piece of the action. 

There are also a number of lightly traded currencies and under-regulated exchanges. Once again, the fraudsters step into an information void and manufacture gains by peddling their own news about currencies they own.

Pump and dump in the modern age

Regulators have done their best over the years to put an end to pump and dump schemes by punishing perpetrators, but the type of person responsible for this type of security fraud has changed over the years.

The perpetrators used to be mainly unscrupulous brokers such as Jordan Belfort and his brokerage (the infamous protagonist in the movie The Wolf of Wall Street) making cold calls on the phone, but now they can be anyone with a platform. Touts operate through subscription services, podcasts, webcasts, message boards, Facebook, Twitter, Signal and even TikTok. 

The number of retail investors has also surged over the years, meaning there’s that many more marks for the pumpers and dumpers to pursue. And the prevalence of online brokerages means individuals can execute their own trades without the help or guidance one used to receive from an experienced broker who might be quicker to spot potential fraud.

A modern pump and dump case story

A self-proclaimed penny stock guru was recently charged with fraud by the SEC for his role in a pump and dump scheme. This is not an unusual occurrence, but this particular case illustrates how sophisticated modern pumpers and dumpers are.

The guru had an investment website and an email newsletter which went out to several thousand investors every week. He claimed to have his own secret strategy for picking winners and his website boasted of his great wealth and many successes. 

He was able to charge subscription fees for access to his newsletter because, more often than not, the guru was right. 

Each week the newsletter would tout a penny stock and almost without fail news would soon break about the company anticipating record profits or nearing a technological breakthrough. 

What his subscribers didn’t know was that the guru was working with a network of fellow scammers. 

It worked like this: the guru had partners, one of whom was adept at social media and another who hosted a fairly popular stock-picking webcast. Before each week started, the three would choose a lightly traded penny stock to target. The guru would tout this stock (let’s call it XYZ Widgets) in his newsletter. 

As the newsletter was circulating, the masterminds would take sizable positions in XYZ Widgets. Next, the webcaster would make his picks public. Newsletter readers were already buying in, pushing the stock price upward, which gave the webcaster evidence to show his viewers that XYZ was on the rise.

The final step was the social media portion. The social media expert employed a small team and together they would launch a large misinformation campaign about the company. Using Twitter and Facebook as well as various stock picking message boards, they would spread false news items along the lines of “XYZ Widgets up substantially on news of an enormous new federal contract.”   

These “news” items would reel in other investors, but as this last group of new investors bought in, the scammers would begin selling their positions and pull in substantial profits. 

Since they had such large positions, when the three scammers started selling, the stock price would plateau and begin to fall. Often this would produce a bit of a panic amongst some of the new investors and soon enough the price of XYZ Widgets would be in freefall.

That was of little concern to the three scammers. They would already be on to the next fraud.

Bottom line

Investors lose money in pump and dump schemes when they buy into fabricated hype. Protect yourself by verifying all news items and carefully vetting the sources of any incoming stock tips. 

Trust your instincts. If something sounds too good to be true, in the stock market, it probably is.