By Phil R.
“A fool and his money are soon parted.” – Unknown
“If the fool is not sure how to part with his money, we’ll be more than happy to help.” – 99% of Wall Street
Okay, now we’re going to talk about a subject that’s near and dear to my heart, and that’s the extravagantly shady arena of penny stock investing known as “pump and dump” stocks. It only stands to reason that when you have a vehicle such as the microcap markets, where millions of dollars can be made (or lost) in a matter of seconds, you might as well assume that the crooks are gonna come out to play. And play they do…there are so many stories of pump and dump scams taking place in the penny stock world that it’s really not even funny. It’s one of the oldest tricks in the book, and yet thousands of unwary investors lose millions of dollars every year falling for pump and dump scams. It just keeps happening over and over. It’s absolutely amazing how gullible people can be, especially when less-than-savory stockbrokers or investment advisors or “professional stock pickers” dangle the carrot of stratospheric windfall profits in front of novice stock traders who are looking for the promise of a pot of gold at the end of the rainbow.
Pump and dump scams are really as old as time, and are somewhat akin to the “bubble” phenomenon. In other words, the price of an asset gets inflated far beyond any reasonable notion of value, and due to nothing more than pure hype and insanity-laced euphoria people keep buying it as it continues its meteoric rise. Then comes the inevitable crash–and I mean it is COMPLETELY inevitable–and as sure as the sun rises and sets, there are some people who bought at the very top and are left holding the bag. It happened back in the 1600s when tulip bulbs were all the rage in the investment world, and it continues still today.
One of my favorite investment movies is a somewhat-well-known flick called “Margin Call.” One of my favorite scenes is when Jeremy Irons (forgot his character name) and Kevin Spacey (forgot his character name too) are eating lunch as the market is completely tanking back in 2008. Jeremy Irons covers a brief history of the bubble phenomenon, rattling off several dates in which the markets crashed due to completely irrational investment behavior. Check it out here:
I didn’t mean to get off on the whole “bubble” side of stock market investing, but it does relate to pump and dump scams. The main difference, I guess, is that pump and dumps are far more deliberate and intentional than bubbles. With bubbles, everyone is just in a freakin’ frenzy and half of them don’t know why, but with pump and dumps, it is usually the result of a group of scammers working together to artificially inflate the price of a stock, for the purpose of selling it to other people once the price has gone to the moon. The basic gist of it is that these people buy the stock when the price is very low (because it’s virtually worthless), they hype it to the moon, and when the public finally decides to join the buying frenzy, the authors of the pump sell out at the top, conveniently leaving others to hold the bag. Not too long afterwards (sometimes even within the same trading session), the buying interest dries up, and the price begins to plummet. The charlatans who authored the pump walk away with fat pockets, and the victims who bought at the top walk away with huge losses.
Here’s a basic 5-step anatomy of the average pump and dump stock:
1. Con-Man Guy decides that he wants to pump a stock. He makes his selection (usually a penny stock, mostly on the OTC exchanges) and buys a ton of shares at a very low price. It’s low because the company is crap, and he knows it. The companies that are most frequently pumped are the ones that have barely any market cap at all (most of the time less than $5 million, many times much less). The shares may cost him about 0.002 apiece or whatever…suffice it to say, they’re low as crap.
2. I forgot to mention this part of the setup–many times it’s not just some random dude, it’s often the company management or corporate officers who are looking to hype their company to outside investors. These insiders own most of the stock, and will often pay cash or deeply discounted shares of stock to an outside hype firm in order to promote the stock to the public. The hype firm will then promote the stock by way of sending out print or email newsletters, message board blasting, investment forum spamming, and other delightful techniques; basically, whatever it takes to put the message in front of novice investors with as much excitement and false promises as possible.
3. The more daring pumps often claim that the pump and dump company in question has some kind of ties to a big-name company such as Apple or Amazon, typically in the form of a contract or possible acquisition. The language is highly speculative, and contains the all-too-famous “forward-looking statements” that all P&D stock promos are known to have. In addition, pump and dump stocks usually focus on the “sexy” industries such as biotech, defense, or Silicon Valley-ish stuff.
4. Once the public has sufficiently bought into the stock–an event that is often triggered by a high-subscriber-count penny stock newsletter “alert”–the price of the stock shoots up to completely ridiculous levels. At or near the peak of the action, the insiders sell out, more than satisfying the soon-to-diminish demand for the stock, and then the stock price comes crashing back to the ground. Again, this can happen within a matter of days, or sometimes within only one trading session (especially with the OTC issues).
5. At this point, the novice investors have officially been pillaged, and the con men celebrate by buying Bugattis or sniffing lines of coke off of questionable surfaces.
Pump and Dumps: So Easy a 15-Year-Old Can Do It
You may have heard of Jonathan Lebed, the 15-year-old kid who made a small fortune pumping stocks during the completely insane dot-com era. Tons of would-be investors (read: gamblers) were scouring Internet message boards looking for the next hot tech stock pick. Lebed bought penny stocks and then heavily promoted them on various message boards, claiming that the stock prices were going to the moon. Of course, people bought into the hype, and Lebed was able to sell out with nice profits while others held the bag. The SEC eventually filed a civil suit against him, and he settled out of court by paying a fraction of his profits to them. It still amazes me that they would go after this kid for pennies when Goldman Sachs does this at virtually every IPO they underwrite.
Pump and Dump Newsletters
There are tons of penny stock newsletters that serve no other purpose than to broadcast pumped stocks to naive investors. Although nobody will come outright and say it, many of these sites that pose to be “financial newsletters” are havens for pump and dump schemes. Now I’m not accusing or implicating any website for pumping and dumping (because I don’t like lawsuits), but I will offer the following websites as examples for general educational and informational purposes only:
* Stock Runway [http://www.stockrunway.com/]
* Penny Stock Buzz [http://penny-stock-buzz.com/]
* Damn Good Penny Picks [http://www.damngoodpennypicks.com/]
* Penny Stock General [http://www.pennystockgeneral.com/]
* Blue Horseshoe Stocks [http://bluehorseshoestocks.com/] (Gotta love the “Wall Street” movie reference)
There are tons more, but I think you get the drift. They all pretty much look the same too. You can find more sites like this on StockReads.com. Many skilled traders understand the type of business these sites are running, and have made tons of money shorting the stocks that get heavily promoted by online newsletters. For every pump, there will be an inevitable dump, so it makes perfect sense to make money on the way down if at all possible.
And the Pump Goes On…
There are more accounts of pump and dump scams than I care to even research and mention. One recent example is this one. This type of activity doesn’t show any signs of slowing down, because greed will always be a part of human nature. It also doesn’t help that many times a person’s desire for extravagant wealth will often override their ability to think rationally to any degree.
That’s about all I care to write at this time, but I did want to give a decent overview of what pump and dump penny stocks are, just to make sure that beginning investors understand what they’re dealing with. The markets are ruthless in this regard, and you should know that a stock that has skyrocketed 300% in one day is not going to continue its meteoric price rise forever. Be wise, do your homework, watch volume flows, and don’t have inflated ideas of a stock’s potential. That’s all…over and out.
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