Hello. I am Gunjan Grover.
Today we will be discussing a phenomenon present in almost every stock market that has hurt many small investors.
We will be discussing pump and dump schemes now.
In this video, we will tell
What are pump & dump schemes?
How do they work?
How to recognize these schemes and avoid them?
But before moving ahead, don't forget to like and subscribe.
What is a pump and dump scheme?
Pump and dump schemes are one of the oldest forms of securities or market fraud.
It involves inflating the price of a stock or commodity by a big owner through some communication or market action
Once buying momentum is achieved, it is dumped to unwitting victims at a much higher price.
This form of securities fraud is rampant in small cryptocurrencies and microcap companies which have much less liquidity than others.
Pump and dump schemes usually start as positive communications
like spam emails, press releases, telemarketing, cold calling with tips for “hot” stocks, and other forms to reach as many people as possible.
Promoters of pump and dump schemes always try to promote this stock tip as the next big thing
And mainly focus on the reader or listener with grand visions of massive dreams
So that they feel that with this small stock or investment they will become the next Apple, Microsoft, or Bitcoin.
Before the internet era, these schemes were mostly done using cold calling, ads on TV, magazines, and newspapers.
A very famous example of cold calling was seen in the popular movie The Wolf of Wall Street
Here the protagonist Jordan Belfort was seen convincing an unwitting buyer using aggressive sales tactics to invest in a penny stock.
The real Jordan Belfort and his real-life firm Stratton Oakmont have also been criminally convicted by the SEC
for artificially inflating the price of an owned stock through false and misleading positive statements, to sell the cheaply purchased stock.
Another famous example of a pump and dump is Enron Corporation of the USA
It had inflated the stock using false profits while the executives of the firm were busy selling their stake to the public.
How does such a scheme work?
Every pump and dump scheme starts with positive communication by the promoter of the investment or stock.
The stock is usually very small with very little information available about it in the market and very little liquidity present.
The major focus currently is to promote this stock tip as the opportunity of a lifetime
So this stock is still very small and is available with unlimited potential.
There is usually no mention of any risks involved with the investment and focused solely on the positive sides.
The major reason for choosing a small stock with less liquidity and little information
It is much easier to control the narrative and manipulate public
Then bigger stocks require a much higher amount of capital for stock price movement and verifiable information is available to the public.
The fraudsters will be justifying the narrative using inside information which is not available to everyone
When this information will turn the stock into a goldmine once it is released publicly.
In the next phase, once the promotion is at its full momentum and people have started participating in it,
the promoter will use their own capital to buy large amounts of the stock to show there is a massive demand for this stock.
Being illiquid, the stock price rise will require less capital
It can hit the upper circuits making it seem that the demand is very high and inducing FOMO or fear of missing out.
Then buying pressure is created.
When enough organic buying momentum is generated from individual investors who have bought into the narrative,
the scheme promoter will now start to liquidate or dump at a much higher price.
Once the stock loses its upward momentum and there are no willing buyers at a high enough price,
there are only speculative sellers left in the market.
By this time, the scheme promoter has already sold off their stake and taken their profits
While the new owners who have not sold yet are left in a seller’s market
As prices collapse, these new investors lose out on their investment as there are no buyers left at the previous high levels.
The stock returns to its previous state and the investors are left with a stock that is not worth the price that they paid.
How to recognize and avoid these schemes?
The thing to be noted here is that all pump and dump schemes always involve promises of returns from small companies which is not practical.
They say it's inside information or tips which cannot be verified.
They create the FOMO element to make the investor hurry and not complete proper due diligence before making the buy decision.
So an investor should always follow a set due diligence process
Here they should research properly and consider all sides of the coin before investing.
At the most basic level, we should evaluate the basic risks and opportunities involved.
It has the risks involved with investing in such stock be seeing all the warning signs that avoid them.
In the case of less verifiable information, we should avoid such a stock than gamble whether the inside information or tip is correct or not.
It is always good to remember that investing is never as easy as just investing based on a small information tip
You should only invest in things that you understand or have been recommended by a trusted and knowledgeable advisor.
Even legendary investor Warren Buffett let go of blockbuster investments like Google and Amazon in the past
Because he was not ready to invest in a business that he did not understand and was not confident in.
He has also mentioned that he regrets doing so, but it has helped him avoid all the millions of other loss-making
Google and Amazon at that time were called blockbusters.
To remember, to avoid falling into such traps is that missing such an investment opportunity is not the end of the world
We will get many such opportunities in the future.
Investing in stocks is like planting seeds.
Both take time to bear fruit.
So we should always have patience.
Lastly, it is to keep this in mind, “If it’s too good to be true, it probably is.”
The rise of the internet has added a new dimension to pump and dump schemes.
They have opened new avenues for fraudsters to reach a lot more people through email, social media, and public internet forums.
Social media platforms that have less regulatory scrutiny and higher anonymity
Like Telegram, Discord, and Reddit have become breeding grounds for pump and dump schemes.
Everyone is opening their channels and giving tips on investment.
Thus, investors must remain extra cautious in treating all information from unverifiable sources carefully
Before investing, they should fully understand the risks and rewards.
So, that was it for today’s episode.
On what topics do you want us to make more videos? Let us know all this in the comments!
We don't recommend any stocks and all of these are for educational purposes.
We have started a new channel called Groww plus where we post content around career, health, investing, entrepreneurship.
You can find the link to the channel in the description.
On that note, here's me Gunjan Grover. Signing off
Bye-bye. Take care Keep calm. Invest On.