Pump and dump schemes are a form of market manipulation where a group of individuals artificially inflate the price of a stock by buying large amounts of it and promoting it through various means, such as social media and messaging platforms. The goal of these schemes is to generate hype and interest around the stock, causing more and more investors to buy in, and driving up the price. Once the price reaches a certain level, the individuals behind the scheme will then “dump” or sell their shares, pocketing the profits at the expense of unsuspecting investors who are left holding a stock that has dropped in value.
One example of a pump and dump scheme in the Indian stock market occurred in 2013, where a company called QuestNet was accused of running a multi-level marketing scheme that had defrauded investors of millions of dollars. The company had been promoting its stock through false and misleading statements, causing the stock price to artificially inflate. Once the stock price had reached a certain level, the company and its associates then sold their shares at a profit, leaving the investors who bought in at the higher price with significant losses.
The fraud was detected by the Securities and Exchange Board of India (SEBI) and the company was banned from the market. In addition, several individuals associated with the company were also charged with securities fraud and money laundering. This example illustrates the importance of researching a company thoroughly and being aware of red flags such as hyped up stocks, insider trading, or suspicious trading activity before investing in the stock market.
Pump and Dump schemes may start anywhere on the internet. For instance, it may take place using an e-mail spam campaign through several media channels via fake press releases or probably through telemarketing. In such cases of the Pump and Dump schemes, the stock broker/analyst often claims to have the “inside news”. Newsletters also claim to have unbiased recommendations and so do the stock messages.
When a promoter’s campaign to “pump” a stock is successful, it will attract potential investors to purchase the shares of the target company. The increased demand for that particular share and of course the trading volume will convince more number of people to believe the hype and eventually to buy shares.
A modern spin on this “pump and dump” scheme is known as “Hack”. This could be defined as where a person purchases penny stock in advance and then uses compromised brokerage accounts in order to purchase even more quantities of that stock. The end result of such a case is the price increase that is pushed further by day traders when a quick advance is noticed in the stock. The stockholder then sells off his stock at a premium price.
While talking about “Pump and Dump”, the point that deserves attention, is the “short and distort”, variant of the pump and dump scam. In this process, instead of first buying the stock and then artificially raising the price of the same, the scammer first short-sells the stock, then artificially lowers the price using the aforementioned techniques. The scammer covers his short position eventually when he buys back the stock at a lower value.
In recent days, a considerable number of ‘pump and dump’ activities in the stock market has come under the scanner of market regulator SEBI. The regulating body suspects certain brokers are luring small investors by these artificial methods of high trade volumes. The pump and dump cases have been found to be quite prominent in the mid-cap stocks, and importantly in the infrastructure sector. SEBI is trying to figure out the best possible ways to reduce the ‘pump and dump’ schemes from the stock market.
Besides, figuring out and detecting the possible cases of market manipulation, SEBI is also trying to help out in building linkages between several transactions and allied activities of the networked entities.
The National Stock Exchange of India (NSE) has recently cautioned investors against the Telegram channels that was offering guaranteed returns in the stock market. This is not the first time that regulators have cracked down on market operators for allegedly manipulating stocks through social media channels, particularly Telegram.
It is important for investors to be aware of such schemes and to exercise caution when receiving stock tips or recommendations through social media or messaging platforms. Gullible retail investors who are always looking for stock tips often end up being trapped in pump-and-dump schemes, which can result in significant financial losses.
Investors should also be aware of the red flags that may indicate a pump-and-dump scheme is taking place. These include a sudden and sharp increase in the price of a stock, heavy promotion of the stock through social media, and a lack of fundamental reasons for the stock’s price increase.
How Investors can Avoid Investing in Stocks behind Pump and Dump Schmes
Research the company: Investigate the financials, management, and industry of the company to ensure it is a legitimate business with long-term potential.
Avoid hyped stocks: Be wary of stocks that are being heavily promoted through spam email, social media, or online forums, as they may be part of a pump and dump scheme.
Watch out for red flags: Look out for signs of insider trading or suspicious trading activity, such as a sudden increase in volume or price without any news or fundamentals to support it.
Diversify your portfolio: Spread your investments across different stocks and sectors to reduce the risk of losing your entire investment in one scam.
Be patient: Don’t make impulsive decisions based on short-term market fluctuations. Instead, focus on the long-term performance and potential of a company.