Friday, November 17, 2006
The art of the pump and dump
The art of the pump and dump
We all get these most annoying emails, faxes even snail mails. They speak of great wealth, the next Microsoft and a company that is about to make more in a day than any other has made in a year.
The letters go on to say a target for the stock, which is usually several times the current value of the shares. Usually these stocks are penny stocks with a value of less than one dollar but they can be high priced per share too.
The target stock is usually an unsuspecting, sometimes bankrupt company. The stock has a low daily volume and little interest from current investors. The company might as well exist in a ghost town in your favorite scary movie. No one could tell a difference because the stock is sometimes all that’s left after a crazy CEO decides to rob the company for all it’s worth. This is especially true in the case of pink sheets, worthless shells of companies that will never come back from the dead. You never know, you might be buying parts of Enron when you buy that $.00003 a share stock.
The person behind the operation has been in careful planning for a time period of up to a few months. The operator of the scheme has to be careful to take a position in the company without drawing attention to himself or others operating the ring. Submitting a bid order for too much stock could cause the markets to attempt to correct the difference and send the price of the stock upward. This is not what the operator wants to do, the best thing that could possibly happen would be for the price to fall as the operator buys in.
Because the majority of these companies share for share are worthless, the operator often has to buy tens of thousands of shares to make it worthwhile. Some brokers limit their orders to 10000 shares then $.01 a share after that. This makes it difficult for the operator to buy extremely low priced shares. To make it worth the while, most shares involved in these operations sell for $.10 or higher. The brokers commission gets out of hand on any company with a share price lower than ten cents.
Another point, the only people who always gain from the markets are the brokers. They provide the exchanges for a small fee that offers them zero risk. The money that flows through the markets isn’t new wealth, its just money being sent between different people. The brokers are the only ones who win in this negative odds game of trading stocks.
Now the promotion starts. The operator has to bring in a large amount of purchasers in order to drive the price as high as he can. As we know already, increased demand will lead to the ultimate rise of the share price. The operator will usually buy bulk lists of fax, email, mailing addresses in order to get the message out.
For just a few minutes of his time, the operator can send a message to millions of email accounts. Even if the message is read and followed by 1 out of every 1000 people the return rate will be great for the operator. The unsuspecting investors rush in to buy into what seems like the opportunity of a lifetime. The operator usually has an extremely well crafted sales letter to pitch the investment to the ordinary person looking to strike it rich.
It is human nature to be lured by fast wealth. The letters promise near instant returns in the hundreds of percentage points.
The investors start buying into the security and push the price up. With each new investor, the operator of the pump and dump slyly sells his shares. The operator generally sells as the stock is rising and is entirely out of the stock before the price crashes. When pump and dumps occur they usually cause the value of a stock to go straight up then right back down in a shape that looks like and upside down ice cream cone.
The operator sells his shares to all the new investors who think they just got involved in the ride of a lifetime. The operator can slip away with thousands, maybe millions of unearned dollars. The new investors realize soon that they are in the possession of tons of worthless stock.
This scheme is run all the time, around the clock and leads to the loss of several billion dollars a year by defenseless investors. The issue sparks from the ease of running such a scheme and the availability of people who are willing to invest before researching. During the tech bubble a teenager manipulated this same scheme to defraud investors out of nearly one million dollars.
Do not invest in any of the stocks mentioned in mailers. These stocks are usually junk companies that no longer exist. The operator is merely pumping to make a quick buck.