In the world of stock markets, you can come across hot stocks that look too good to be true! Have you ever come across one? Slick scammers can make quick cash using the ‘pump and dump’ scheme, whereas, an unsuspecting trader are left holding the bag. Stock markets are like a minefield with hidden traps that can easily take away your hard-earned cash. The good old-fashioned, ‘pump and dump’ scheme is one notorious trap that has been around for decades. Know how to avoid this dirty tactic in this blog with us!

What is the 'pump and dump' scheme?

A classic case of market manipulation, the ‘pump and dump’ scheme is still going strong. Let’s understand how it works.

Scammers and fraudsters inflate stock prices artificially by spreading lies and false information and this is referred to as the pump. Every day traders think that they have stumbled upon the next big thing due to the false information being circulated in the market.

As for the dump part, scammers sell their shares as soon as enough people have joined the bandwagon, resulting in a steep fall in stock prices! All you are left with is worthless shares that have no value.

Sounds nasty, right? With the growth of social media and online forums, ‘pump and dump’ is stronger than ever now.

The red flags of the scheme

Spotting these scams before it is too late is essential and keeping an eye on certain signs in the markets can be helpful.

Proceed with caution if you come across a stock that is being unbelievably hyped and being touted as ‘the next big thing’ in the market. Scammers make use of this sense of urgency and the FOMO of an individual to pull off such scams. Do you know what is an important red flag? Sudden and unexplained jumps in stock prices. Especially, when the stock is of a lesser-known company, it is a reason to worry. Gradual growth in stock value over time is an effective indicator of genuine stocks.

If there is a sudden rise in the trading volume of a little-known stock, then you must understand that it might be a scam. The illusion of demand is created by scammers by purchasing a large volume of stocks!

Unsolicited emails, random social media posts, and forums can be a source of misinformation and are worth scrutinizing. Make sure that you are able to trace the information to some reliable and legitimate source before diving into purchasing such stocks.

Penny stocks are the ultimate breeding ground for ‘pump and dump’ schemes! These stocks lack institutional scrutiny, making them easy to manipulate. Moreover, these stocks are also thinly traded as well.

Modus operandi of scammers

Recognizing these schemes can be easier if you know the process in which they are carried out.

First, these scammers select a stock that has a low price and is thinly traded. Such stocks generally belong to a company that has little public information available.

Next comes exaggerated claims regarding the potential of the company, which are all false using social media, forums, and newsletters. The phrases like ‘undervalued gem’ and ‘guaranteed profits’ are used to hype the stocks.

Unsuspecting traders pile in as soon as these false rumors start spreading and taking effect. Scammers purchase more stocks to keep the hype on!

As the price reaches its pinnacle, scammers sell their shares at a high profit, resulting in a sell-off cascade. What happens next? The stock price plummets.

As a latecomer, you are left with near-worthless shares, as the scammers walk away with fat profits filling their pockets.

How to stay protected?

Feeling afraid? Well, it is natural if you are a beginner in stock markets, but stay relaxed, you need not essentially fall victim to such a scam. Make use of a little caution and smart trading habits to bail you out of such situations in the future.

Take time to research the company and do your homework well before placing your baits on any kind of stock. Look for reliable information about the economic aspect, the management, and recent news of the business to avoid any traps.

If you have received a stock tip from an unknown source, be very skeptical of it! When you get to hear that a stock is exploding, verify the source. Don’t people like to keep such news to themselves?

Putting all your eggs in the same basket can be a mistake when the basket crashes. Portfolio diversification is of immense importance and spreading all your assets across different industries and sectors can be helpful in such dire scenarios.

Scams are highly probable in the case of penny stocks, which have become the breeding ground of scammers. Avoid such stocks and stick to well-established companies.

If there are flashy headlines and over-the-chart promises associated with a stock and it seems too good to be true, stay away from it.

Don't let FOMO drive your decisions as proper analysis is extremely crucial in ensuring the selection of appropriate stocks. Besides, stick to trusted trading platforms only!

What to do if you find one?

If you find out that you have come across a pump and dump scheme, firstly make sure to report it as soon as possible. Notify any brokerage platform or regulatory authority immediately and help others from falling victim to the scam as well.

Avoid participating in any kind of hype and make sure that you are not the collateral damage in such a scenario! How would you feel to know that you have stocks that are completely worthless?

Warn others of any such malicious activity and ensure that others are not getting caught up in such a scheme. It is a moral responsibility as a fellow trader to raise the alarm on such scams.

The bottom line

Greed, fear, and ignorance are the three main areas that pump and dump scammers prey on! Impulsive decisions made out of FOMO and anxiety can often result in you falling prey to such scammers and losing a lot of your funds. Take your time to analyze any such stocks and claims and make appropriate trading decisions at all times!