A pump-and-dump scheme is a type of market manipulation and financial fraud in which members of a group buy securities and then convince others to do the same. The goal is to illegally "inflate" the price of an overvalued stock, cryptocurrency, or other investment. But soon the price plummets and the pump-and-dump strategy collapses. Let's take a closer look at how this pump and dump system works and how to avoid it.
What is a pump and dump program?
A pump and dump scheme is a deceptive scheme that aims to increase the price of a stock or investment by making false recommendations. These recommendations are based on inaccurate, misleading or grossly exaggerated claims. The perpetrators of dump and dump scams already have positions in the company's stock and will sell them after the hype drives the stock up. But pump and dump signals are also safe and legal, so watch carefully so you don't make a mistake.
Under securities laws, this activity is prohibited and can result in large fines. The growing popularity of cryptocurrencies in the industry has led to the emergence of pump and dump transactions.
How does the pump and dump program work?
Cold calling was commonly used as a pump and dump tactic. Most of these online activities have evolved since the Internet; Scammers can now send hundreds of thousands of emails to unsuspecting targets or post reports online, tricking investors into buying stocks quickly.
These messages usually claim to contain inside information about an upcoming event that will cause the stock price to skyrocket. As buyers flood in and stocks soar, fraudsters sell their stocks. In these cases, the volume of shares sold is often large, leading to a sharp drop in the share price. In the end, many investors suffer huge losses.
Pump and Dump strategies target micro- and small-cap stocks on OTC exchanges, which are less regulated than official exchanges. Because they are easier to manipulate, micro- and small-cap stocks are better suited for such abusive behavior. Small-cap stocks typically have low trading volume, little free float, and little information about the company. As a result, it doesn't take many new buyers to increase the stock. Read how to quickly sell cryptocurrency on this site.
Pump and dump in pop culture
The pump-and-dump strategy inspired two hit movies: Boiler Room and The Wolf of Wall Street. Both films depicted a warehouse full of telemarketing stockbrokers offering penny stocks. In each case, the brokerage firm was a market maker and held significant stakes in companies with dubious prospects. Brokers were offered high commissions and bonuses in exchange for placing shares in as many customer accounts as possible. At the same time, brokers raised the price by selling large volumes.
When the volume of sales reached a critical mass and there were no buyers, the company sold its shares at a large profit. This caused the share price to fall, often below the initial sale price, resulting in significant losses for customers who failed to sell their shares in time.
Pump and Dump on the crypto market
The crypto market has become the newest place for pump and dump scams. The extraordinary success achieved by Bitcoin and Ethereum has created a huge interest in cryptocurrencies. Unfortunately, due to the lack of regulation in the cryptocurrency market, its lack of transparency, and the technical complexity of cryptocurrency, cryptocurrencies are particularly well-suited to fraud.
A 2018 study looked at the impact of pump and dump strategies on the Bitcoin market. Over the course of six months, researchers monitored two prominent group messaging platforms used by cryptocurrency speculators and discovered more than 3,400 such schemes.
The US Commodity Futures Trading Commission (CFTC) in March 2021 urged clients to avoid pump-and-dump patterns that may occur in trading or emerging cryptocurrencies. The CFTC also announced a program that would allow any whistleblower to receive a monetary reward of 10% to 30% if they disclose original enforcement actions that result in economic penalties of $1 million or more for pump and dump.
Eleena Timmons