Tips to recognize and avoid pump and dump schemes
After the infamous Ponzi scheme, the next big scam that is happening is called the pump and dump scheme. The Internet is ripe with novice investors who could be easily influenced into investing their money into such pump and dump schemes.
So, what exactly is a pump and dump scheme? Do the perpetrators get caught and punished? Is there any way to avoid pump and dump schemes? How exactly can you recognize such schemes? To know the answers to these, simply read on.
What is pump and dump scheme?
Pump and Dump, also known as ‘Ramping’ is an internet scam. Here is how it works – the investors of a particular stock aggressively promote the stock through various means. It could be done through press releases with glowing reports about the financial health of the stock, or by providing ‘insider information’ about a new product or innovation in the company which could potentially catapult the price of the stock within a few days.
Suddenly, there would be mentions about this new ‘hot’ stock in newsletters, bulletin boards, social networks, chat rooms, or even from analysts on TV or Radio. Unsuspecting investors get caught in the bait and quickly invest money into the stock. This further drives up the price of the stock.
As soon as the peak price is reached, the original fraudsters or pumpers (who had invested at a very low price) exit their entire stock. Then all the hyping of stock ceases, causing the price of the stock to tumble down. Eventually, investors lose their hard earned money that was invested.
Unfortunately, there are no real regulatory authorities to control such Pump and Dump schemes. Hence, it is always best to recognize and avoid such schemes than getting caught in them and try to get compensation for the money lost.
How to Recognize a Pump and Dump?
Below are some red flags that indicate that the stock is showing signs of pumping activities.
- A Reverse Merger happens out of the blue. A private company would merge with an existing public company, gain control, and start trading its penny stocks. Now, the new private company is NOT liable to disclose its financial assets, risks, liabilities and other legal information. Basically, it is just acquiring a shell company. More often than not, this forms a perfect setting for penny stock scams like pump and dump. Be particularly wary if the private company who did the acquisition is less than two years old.
- Shares of the company are listed in Pink Sheets. Very few of the companies listed in Pink Sheets are genuine and honest. The Pink Sheets are not regulated by SEC, making it lush ground for pump and dump schemes. Be warned that being listed in OTCBB also doesn’t warrant the stock to be trustworthy.
- Financials seem dodgy at first look. Assume that the company has been reporting losses consistently, but its share prices are suddenly skyrocketing. This in itself is a huge red flag. Another bad sign is listing of huge assets with very little revenue to show for it.
- Too many promotions and marketing of the stock. Multiple press releases, analysts trying to hard-sell the stock as ‘strong buys’, new deals or launch of new products all of a sudden – all these should immediately bring up your guard. Such self-promotions usually are dubious at best.
- Check the company’s filings with the securities regulator of the state in which it is located in. Usually, they would have to file their information at their state. If the information looks suspicious, avoid that stock like the plague.
- The volume of a stock goes up from zero to hundreds of thousands in a single day. This has a 99% probability of fraud.
Another simple but effective way to check out if the company is genuine is by doing a google search of its office address. Then switch to the street view and see what pops up. Abandoned plots, P.O boxes, trees, and vacant buildings are all just scams, plain and simple!