Donald Gayhardt

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How to Recognize and Avoid Pump-and-Dump Schemes

How to Recognize and Avoid Pump-and-Dump Schemes

Investing in the stock market, as well as in similar markets such as cryptocurrencies, can be an effective way to make money on the side without putting in much effort. That said, investing in any market isn’t without its risks. Yes, you could make money this way, but it’s also possible that you could lose money.

That’s why you should do some research before making an investment. While this involves some effort, you’re much more likely to earn a passive income in the long run if you take steps to learn about what you’re buying.

In the meantime, you should also familiarize yourself with some of the risks involved in buying and selling stocks. Specifically, it’s a good idea to understand what “pump-and-dump” schemes are and how they can cause you to lose money, instead of helping you make it.

 

New Investors

 

stock exchange

 

Pump-and-dump schemes are common in any market where investors can purchase volatile shares, which can quickly and dramatically shift in price. For instance, barring extraordinary circumstances, the price of real estate doesn’t typically change all of a sudden. That’s not always the case with stocks and similar investments.

This gives unethical individuals an opportunity to take advantage of investors who have not done their research or who are still learning the basics.

A pump-and-dump scheme refers to the practice of artificially inflating the price of a stock. It’s often used to influence the price of inexpensive stocks, although that’s not always the case.

There are several ways to “pump” a stock so the price rises. Often, pumpers work in groups. They purchase large shares of a stock when the price is low, which can sometimes trigger a small increase in price. Then they look for ways to convince new investors that the stock has massive potential. They visit online message boards and social media platforms, where people discuss stocks, telling them—falsely—that a particular stock is on the brink of a major increase in price. Sometimes they release information that resembles news reports, claiming that a company’s stock is set to rise, when in fact there is no real catalyst that would cause a sustained price increase.

Their main goal is to convince others that they’ll be missing out on a major opportunity if they don’t buy the stock at the low price. If pumpers are successful, they generate enthusiasm, and many more people begin purchasing shares.

This causes the price of the stock to rise briefly. However, the pumpers know the company doesn’t actually have enough real value to sustain a higher price. Before this becomes apparent to others, they sell all their shares, “dumping” the stock and taking a profit.

Unfortunately, this causes the price to suddenly drop. This leaves many others holding shares that are, at best, worth much less than what they expected them to be worth. That’s the best-case scenario. Sometimes the price remains high enough for other investors to still make a modest profit.

That’s not common, though. When pumpers dump massive numbers of shares, the price can drop so low that other investors are left with shares that are worth substantially less than what they paid for them. People can lose a lot of money this way.

 

Identify the Signs

It’s important to identify the signs of a pump-and-dump scheme before buying shares. It’s easy to get caught up in a sense of urgency when the price of a stock starts to rise dramatically. Many new investors fear missing out on an opportunity because they believe that by the time they finish their research, the price will be too high for them to make a substantial profit.

While this is an easy impulse to understand, giving into it can have dire consequences. If you participate in a message board or similar platform to discuss stocks, be wary of anyone who claims a stock is primed for a major increase in price without explaining the exact catalyst for that increase. Ask what the catalyst is before making a purchase. If they don’t offer any more information, there’s a good chance that they’re simply trying to pump the stock. Even if they do name a catalyst, you should do your own independent research first to confirm the validity of their claims.

 

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Research Is Essential

Research is an essential step to take before investing in anything. You don’t have to participate in online message boards to fall prey to pump-and-dump schemes, as it simply involves buying a stock experiencing artificial price inflation.

That’s why it’s important to learn about investing before you rely on it as a form of making passive income. While conducting initial research may take time and effort, it will also prevent you from losing money in the long run. On top of that, when you conduct your own research, you’ll be much more likely to choose investments that will make money.

 

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