Stock market scams and how to avoid them – Pump and Dump

October 4, 2023

Several stocks have given 1000% returns within a few months. Who could have predicted that kind of rally for any stock? Hardly anyone. Most rallies are a surprise.

However, many people do predict massive gains for various stocks. Several channels and groups on YouTube, WhatsApp, and Instagram make tall predictions.

  • This ₹20 stock will go to ₹50 in one month.
  • This ₹30 stock will touch ₹300 in three months.
  • Your investment of ₹2,000 will become ₹1,00,000 in six months.

Such predictions are almost always wrong. So why do they make these predictions?

To pump and dump the stock!

Market operators may buy a penny stock and create excitement around it. Any person or entity that can significantly influence a stock’s price is a market operator. A trader with just ₹5 lakhs could influence a ₹10 Cr market capital company, while a company worth ₹1000 Cr could be manipulated using ₹5-10 Cr.

They create excitement around some stocks by peddling ideas through

  • Ad-powered posts on YouTube, Instagram, Facebook, and Twitter,
  • Telegram and Whatsapp groups,
  • SMSes, and
  • Emails.

These operators work in sync. They buy and sell penny stocks among each other to artificially pump up the price. Sometimes, promoters may be involved, too. They trade with related parties or other operators.

Since the purpose of such market operators is to manipulate retail investors, let’s call them scammers. Scammers can get access to your phone numbers and email addresses by malicious social engineering and purchasing your contact information. Some predatory lending apps and free online services are often willing to sell your contact information, as it is a revenue source for them.

The prospects of quick gains can sound exciting. Small investors may flock in, pumping the price higher. Market operators quietly exit (dump) at high prices. Trading volumes suddenly fall. The price starts declining. When small investors try to restrict losses by selling, there are not many buyers. The selling pressure further causes the prices to decline. Small investors are left with big losses.

How to avoid falling for such scams?

  • Penny stocks could be rigged, bankrupt, or dying. Microcaps are risky, too. Avoid such stocks as their information flow is infrequent and mostly irregular.
  • Be careful if a stock sees extreme movements in price and volume.
  • If an opportunity looks too good to be true, it is probably false. Avoid it.
  • Conduct your own analysis, and do not rely on sensational or urgent information.
  • Play safe with mutual funds if you do not want to analyze.

This is the first in a series of blogs I will write covering different stock market scams. Stay tuned to read the next one, which will be on how Phishing is used to scam traders and investors.

Content, Zerodha Varsity

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