Pump and dump is an illegal investment scheme used to increase the value of a stock. Con artists buy up large amounts of low-cost stock, artificially inflate the value with false claims, and then sell the stock for huge profits. When the large blocks of stocks are sold, the stock becomes virtually worthless. Usually, investors who were not aware of the scheme lose their money.
In the past, pump and dump schemes used telemarketing to advertise the stock. As of 2009, the Internet is commonly used to inflate the stock price. Pump and dump stock prices are inflated by advertising false claims in media releases, chat rooms, and bulletin boards. The schemers talk up a new product or service that the company is offering, and tell investors to buy now or lose out on big profits.
As investors start buying the stock, the price goes up. At this point, the people perpetrating the scam sell their stock for huge profits. After the stock is sold off, the price plummets. Anyone not in on the scam is left holding stock that is virtually worthless.
Typically, pump and dump schemes target small, or micro-cap, stocks. These are easier to manipulate than large company stocks. Such stocks usually trade over the counter (OTC) instead of on a large stock exchange. There is less information available about them. Many do not need to file financial statements with the Securities and Exchange Commission (SEC).
Investors can avoid pump and dump schemes by completing their own research before buying any stock. Potential buyers can also consider the source of the information about a stock. If a stranger sends an investor information about a stock with a strong, urgent recommendation to buy, it could be a pump and dump scam.
Sales records are also a good indication of pump and dump. Claims of new, innovative products and services should have a lot of sales to back them up. Without such sales, these claims have little basis in fact. Many times, companies touting a new product will have a good sales history with other products.
Investors can also check SEC records to research a particular stock. Most legitimate companies file financial statements with the SEC. If these records are not available, the investor can search for information from another third party to back up any company claims. If information cannot be verified by any third party, this could indicate that the stock is part of a pump and dump scheme.