A:

A pump and dump scam is the illegal act of an investor or group of investors promoting a stock they hold and selling once the stock price has risen following the surge in interest as a result of the endorsement.

The stock is usually promoted as a "hot tip" or "the next big thing" with details of an upcoming news announcement that will "send the stock through the roof". The details of each individual pump and dump scam tend to be different but the scheme always boils down to a basic principal: shifting supply and demand. Pump and dump scams tend to only work on small and micro-cap stocks that are traded over the counter. These companies tend to be highly illiquid and can have sharp price movements when volume increases. The group behind the scam increase the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has formulated, the group will sell their position to make a large short-term gain.

An Example:
During the summer months of the stock below a pump and dump scheme was initiated by using a "wrong number" scam. A message was left on victims answering machines that talked of a hot stock tip and was constructed so that the victim would think that the message was an accident.

pumpanddump.gif

As seen in the above chart, the price rose from around $0.30 to nearly $1.00, a more than 200% increase, in a one-week period. This drastic increase was seen along with an equally large increase in volume. The stock had seen an average daily trading volume before the price increase of less than 250,000 but during the scam the stock traded up to nearly one million shares on a number of trading days. The unsuspecting investors would have bought into the stock at around $1.00. As seen above, it fell to around $0.20 - an 80% decline in value for those unfortunate investors.

Note to Investors
Always keep this investment caveat in mind: "If it's too good to be true, it probably is". If someone you don't know gives you a stock tip, stop and think about why they would be so willing to give you such hot information. Do not think that you can make a large and quick investment return because it's unlikely to happen. It's also vital that you do your own research about any investment. This should help you to avoid being duped by such pump and dump scams.

For further reading, see the Investment Scams tutorial and Playing The Sleuth In A Scandal Stock.

RELATED FAQS
  1. What are the top Social Security scams targeted at the elderly?

    Prevent Social Security scams by learning to recognize the most common types of scams that target senior citizens receiving ... Read Answer >>
  2. What are the warning signs of online hotel / travel booking scams?

    Learn more about travel booking scams and how to avoid them. Explore warning signs of possible booking scams, and find out ... Read Answer >>
  3. What is the doctor advisory scam?

    U.S. securities law provides certain exemptions that allow privately owned companies to issue shares of unregistered stock ... Read Answer >>
  4. What are the most common scams regarding Social Security benefits?

    Learn about some of the most common Social Security scams that occur by phone, email and direct mail, and how to recognize ... Read Answer >>
  5. Can I make money advertising on my car, or is it a scam?

    Are car wrap advertising companies legitimate? Some companies are scams, but some car wrap companies offer legitimate ways ... Read Answer >>
Related Articles
  1. Investing

    Protecting The Elderly From Scams

    Here are some of the more common scams aimed at seniors and tips on how to avoid these frauds.
  2. Investing

    What Is Phishing?

    Find out more about this scam and how to avoid it.
  3. Investing

    What Is A Pyramid Scheme?

    Find out how this financial scam works and why you should watch out.
  4. Investing

    Recognize And Avoid "Work At Home" Scams

    From pyramid schemes to envelope stuffing, there are a lot of scams masquerading as legitimate part-time work.
  5. Financial Advisor

    Don't Be A Victim Of These Investment Scams

    Some of the most sophisticated investors on Wall Street have been taken in and if it can happen to them, it could happen to you.
  6. Small Business

    Stop Scams In Their Tracks

    Find out how to protect yourself and your loved ones from financial fraudsters.
  7. Investing

    How To Avoid Becoming A Fraud Victim

    Be aware of your rights as a consumer, and know how scammers work so you can protect your money.
  8. Managing Wealth

    Work-From-Home Scams: How to Avoid Them

    Learning when a lucrative opportunity is – and isn't – legitimate.
  9. Investing

    What is Dumping?

    Dumping refers to exporting a good at a lower price than the price charged for the good at home.
  10. Personal Finance

    6 New Credit Scams To Watch Out For

    It seems that everyone has their hand in your pocket these days. Learn how to protect yourself against these financial scams.
RELATED TERMS
  1. Pump And Dump

    A scheme that attempts to boost the price of a stock through ...
  2. Reloaded

    A slang term meaning that a consumer who was previously defrauded ...
  3. Bottom-Dollar Scam

    Fraudulent claims by swindlers or con artists who prey on job ...
  4. Nigerian Scam

    A scam where the sender requests help in facilitating the transfer ...
  5. Dumping

    In international trade, the export by a country or company of ...
  6. Cross-Firing Scam

    A type of scam in which a business transfers money between its ...
Hot Definitions
  1. Nonfarm Payroll

    A statistic researched, recorded and reported by the U.S. Bureau of Labor Statistics intended to represent the total number ...
  2. Conflict Theory

    A theory propounded by Karl Marx that claims society is in a state of perpetual conflict due to competition for limited resources. ...
  3. Inflation-Linked Savings Bonds (I Bonds)

    U.S. government-issued debt securities similar to regular savings bonds, except they offer an investor inflationary protection, ...
  4. Peak Globalization

    Peak globalization is a theoretical point at which the trend towards more integrated world economies reverses or halts.
  5. Phishing

    A method of identity theft carried out through the creation of a website that seems to represent a legitimate company. The ...
  6. Insurance

    A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an ...
Trading Center