What Is Pump-and-Dump Scheme in Trading
Pump-and-dump is the illegal scheme that put the “Wolf of Wall Street” in prison. If you want to know more about this practice (to avoid its negative effects), keep reading. In this article, we are going to answer the question “What Is pump-and-dump?” and explain how it works.
What Is Pump-and-Dump: Basic Explanation
Pump-and-dump as an illegal scheme that can be applied both to traditional assets (stocks) and cryptocurrencies. The idea behind it is rather simple: a person like Jordan Belfort boosts the price of an asset by spreading false (or wildly exaggerated) information about it.
Jordan himself already holds a large number of stocks (or coins). As soon as the increasing demand for the asset makes its price reach a certain mark, the frauds sell their holdings. The price suddenly drops, leaving a lot of outside investors ruined or bitterly disappointed.
How Pump-and-Dump Works
A person or a group who wants to apply this scheme follows a simple plan:
- They purchase a new asset at a low price. It may be some ShitCoin (SHT) or “promising” microcap stocks (aka penny stocks).
- Then, they start promoting this asset using various means of communication, including word of mouth, cold calls, email newsletters, TV and radio ads, corrupt media, etc. They use phrases like “the investment of the year”, “the next big thing”, “the next Bitcoin”, and so on.
- Impressed by the disruptive potential of the shitcoin, many investors want to buy it. Like in the case of BTC, it seems a good chance to get rich fast. In the crypto community, this dream persists.
- In this manner, the frauds boost the demand for the coin and its trading volume. As a result, the price of the asset skyrockets at some point.
- The group of malicious players sell their coins/stocks and enjoy huge short-term gains. Unless this scheme lands them in jail.
Main Types of the Pump-and-Dump Schemes
There are many variations of the classic pump-and-dump scheme that bad guys can use. A beginner should be aware of the basic types.
- Classic Pump-and-Dump
We have already described it above. Frauds promote their penny stocks or “next bitcoins” through various communication channels new and old. Often, they lead people to believe it’s “inside information”.
- “Boiler room” version
In this context, a boiler room refers to a small call-center with a few dishonest brokers who sell penny stocks using the cold calling method. You might have seen it in the American crime drama Boiler Room. The goal of such brokers is to reach as many people as possible and to sell them “the next big thing”.
- “Wrong number” method
Here we deal with a relatively new modification. Suddenly, you receive a voicemail with “inside information”. Normally, it looks like investment advice from a friend who accidentally sent it to the wrong number. For many inexperienced investors, it looks like a happy coincidence. And needless to say, it’s not what it seems.
- Such tricks look small, but they may be applied massively. As a result, you can see the effect on trading charts.
How to Detect a Pump-and-Dump Scheme
On the trading chart above, you can see all the stages of the game. First, the curve is flat, then the price of the coin starts to grow (pump stage). After reaching the target level, it plummets (dump stage).
To spot a pump-and-dump scam, watch out for several red flags. This time, we will be focusing on crypto, but the basics are the same, more or less.
- Some coin you have never heard of starts being massively promoted in social media (Facebook, Twitter, Medium, etc.)
- The company behind the coin (or its promoters) have a bad or controversial reputation. Your research shows that they were involved in some kind of scandal or fraud. Or have unresolved issues with authorities.
- The price of the coin grows on the background of intense promotional activity.
- The articles that promote the coin mention the events that never took place or refer to something that does not exist or have no importance.
- The company or group that promotes the coin has changed its name and other details more than once.
- The promo campaign is targeted at low-income and low-education people. There are few or no technical details about the coin. Instead, they offer big promises and inspiring memes.
- Normally, the message of the campaign boils down to “Don’t miss a unique chance to get multiple returns — quickly and without any effort”.
- The promoters play on greed and FOMO.
- The promises often look exaggerated or utterly ridiculous. Like 1000% return on your investment or a brand-new Lambo. To boost excitement, scammers use multiple exclamation marks.
How to Avoid Pump-and-Dumps
Here are some tips to help you avoid being scammed.
- Educate yourself. The more you know about how cryptocurrency and trading works, the harder it is for scammers to persuade you to buy their shitcoins.
- Control your excitement and FOMO. If some offer makes you feel you should grab this chance immediately, take your time to think about what value their coin has.
- Look for the signs we listed above. If you have spotted more than one, it’s a huge red flag. Don’t ignore it.
- Remember that cheap coins are cheap for a reason.
- Watch out for the phrases that trigger excitement and make you act immediately.
- Never buy anything before making research.
- Don’t agree when somebody offers you to join a pumping group to make fast and easy gains. Normally, only the group organizers benefit from the scheme.
How Pumping Groups Work
A pumping group is a community of people who seek to make easy money using a pump-and-dump scheme. Officially, they promote themselves as a method to boost a new coin and attract investors’ attention to it.
In practice, such groups are focused on creating a pump-and-dump on a big crypto exchange.
First, the organizers try to attract as many people as possible to their group. The outside members (“hamsters”) are encouraged to promote the coin in social media to build hype.
Then, the group admin sets a specific date and hour when all the group members must start buying the coin, causing a sudden and sharp price increase. Ideally, when the target price is reached, they dump the coin at a profit.
The whole process is well organized. For example, the admins translate “H-hour” into different time zones, for your convenience. They choose a suitable exchange, set the target price, and offer a lot of tips for beginners. Also, they keep their people’s spirits up by sharing inspiring quotes and pics and send out multiple reminders.
Though it looks like a win-win scheme, many ex-members complain they lost their investments because they missed the right moment to buy or sell. The point is, everything is happening really fast and admins have an enormous advantage over the other participants. For instance, they can give the signal to dump when they have already sold their coins at the highest possible price.
Naturally, they are the main beneficiaries.
What Is a Pump-and-Dump scheme: Conclusion
Pump-and-dump schemes may look very tempting, especially in the wake of the Bitcoin success that is still fresh in the memory of many dreamers. But remember it’s a scam designed to siphon money out of outsiders.
Theoretically, you can use this scheme to your advantage if you identify it on a trading chart. But it’s rather risky, so you’d better leave such tricks to more experienced traders.