Pump and Dump Schemes: How to Avoid Them

If you are planning to invest in penny stocks, you should know how to spot a pump-and-dump scheme.

A pump-and-dump scheme is a financial fraud related to securities.

This type of financial fraud is also quite prevalent in the cryptocurrency space.

There are many groups that offer and advertise their pump-and-dump signals to the traders for a price. It is essential to be able to spot such groups or schemes to stay away from such frauds. Mentioned below are some ways through which you can spot pump-and-dump schemes.

What Do Pump and Dump Scams Mean?

As mentioned already, a pump-and-dump scheme is a common stock fraud which has become more prevalent due to internet trading these days. The fraud involves inflating the price of stocks by issuing misleading or false statements through which demand can be created and then allowing whoever owns the stock to sell it at a higher price.

When the people dump the stock, this means they are selling it at an overpriced rate to the defrauded investors. When the price of the stock falls, the investors end up losing their money.

How Do Pump and Dump Schemes Work?

Most of the time, pump-and-dump fraudsters use the internet or their own websites for posting press releases about a specific product.

They may send you a newsletter via email, which can be from an outside expert, featuring excellent reviews about the stock.

Analysts and television personalities may be used for advertising the product, which gives more legitimacy to the product.

In the past, these schemes have involved operators cold calling the investors, something that you would see in The Wolf of Wall Street.

• The internet makes it much easier for brokers to defraud investors by inflating the demand. Investors should thus be careful when investing in such stocks by following a few tips.

How to Protect Yourself from Pump and Dump Schemes?

Scrutinizing the Source

Generally, it is safe to assume that offers found on the internet are usually scams, especially if unknown persons email them.

• It is safe to assume that they are scams until you have conducted thorough research to determine the legitimacy of the offer.

In most cases, simply searching for the name of the product along with the word ‘fraud’ will provide many possible results of the product from which you can ascertain whether the product is, in fact, a pump-and-dump scheme.

Find Out Where the Stock is Trading

You should find out where the stock is trading.

Is it trading on the NASDAQ stock market? Is it on the New York Stock Exchange?

Or is it available on some other national exchange?

• If it is available on these well-known exchanges, it is probably not a pump-and-dump scheme.

Fraudulent investments usually do not meet the requirements for trading on a national exchange or the NASDAQ. They are typically found on over-the-counter markets, pink sheets or bulletin boards.

Verify the Stock Independently

Any company can claim that its stock is the best form of investment and any fraudulent company can pay promoters for giving glowing reviews.

Before you make an investment it is crucial that you verify any and all claims which are being made about the stock.

You can confirm such claims through internet research or by calling around a few different financial professionals, or you can even contact your state securities regulator for information.

Avoid Red Flags

If the promoters of a particular stock are making high-pressure sales tactics in order to get a sale, odds are they stand to gain much more than you would.

• Before you buy any stock, you should ask and read up on the investment prospectus or on the company's current financial statements.

You can also look at the EDGAR database on the SEC (Securities and Exchange Commission) so that you can see whether the product is registered or not.

Contact an Attorney

If you think you may be a victim of a pump-and-dump scheme, you may call the securities and investment fraud law firms which may be able to provide a free consultation to you.

You may be able to recoup your losses this way.

Contact an Expert

In order to avoid falling prey to such pump-and-dump schemes, financial experts warn potential investors to be careful about investing in times when there are all-time highs and to ensure that you are willing to hold an investment for a significant amount of time.

However, you cannot depend on the expert alone and you must do your own research and check multiple sources before you use up all your money on a single investment.

Other Warning Signs

Some of the most reliable indicators that something is wrong include:

Unregistered Stocks: Just like a broker has to be registered by FINRA, a company also has to be registered with the Securities and Exchange Commission, which requires the company to file periodic financial statements.

Absurd Bid-ask Spread: This issue can often be forgotten and can take a toll on your returns. 

• This is usually due to low liquidity which means that to buy stocks, you have to buy the stock and pay a much higher price for it and then you can immediately turn around and sell it for. Most of the time, in the blue-chip stocks which are quite liquid, this spread is minuscule.

The inception of the company before Dodd-Frank regulations: Before the 2010 post-crisis regulations, the companies could be easily set up as shell companies and could also get listed on OTC (over the counter) markets and be used to defraud investors.

Conclusion

In the world of investment, there are many financial frauds.

When you are investing in stock, you must make sure that you have done thorough research and collected all possible information about the company you are planning to invest in.

This way, you can protect yourself from any possible pump and dump scheme, especially if you keep the above points in mind.