How the Stock Pump and Dump Work

In theory, a typical stock being pumped-and-dumped should follow a specific and predictable pattern: 

Step 1 – The Bait

This is the first step where the pumpers share the “good news” on a stock they bought earlier.

They spread the good news via personal emails lists, stock forums, money magazines, social media, words of mouth (via broker) or even go as far as getting the newspaper to write an article on this.

During The Bait stage, some popular sentences you always hear -

“The company is negotiating some hundreds of millions ringgit projects”

“The stock is undervalued and have huge upside potential”

“The stock is dirt cheap … you don’t want to miss out when the ‘good news” come out …. soon!”

“The stock is 20 cents with the target price (TP) of $1.20 …that’s a 500% gain!

Could this possibly be true?

Step 2 – The Rally

During this rally phase, the stock will start moving aggressively with the people who got the “good news” buying and pushing up the stock price and daily volumes 5 to 10 times higher than when the first “good news” posted as the bait was released. 

And every day, for the next week, next two weeks, next month, you’ll see those same subject lines with the same calls to action: Buy, buy, buy…good news coming soon! Target price $1.50 …. jump in now!

And if you’ve already bought, the goal is to get you to buy more.

Step 3 – The Sell Off

The stock pumper generally refer to this as a “temporary profit taking.” In other words, they’re blaming a group of investors taking some profits who are driving down the stock prices.

However, the more likely culprit here is that all those pumpers who bought up million-plus share positions early on and are starting to dump their shares onto a very artificial market.

Unfortunately for the other hapless investors, most of those shares were sales executed by these pumpers as the stock plummeted below the price where most of them bought in.

Step 4 – The Rebound

Eventually, with enough work, enough spam, and enough new names pouring in thinking they are getting a bargain, the selling tide abates and the stock moves up again.

During The Rebound, popular sentences you always hear -

“The stock is a bargain at this price, buy now before it move again!”

“The stock is technically oversold and ready to resume its rally!”

“I just bought 300 lots at this cheap price.Getting ready for the bounce.”

In the next couple of days, the price does indeed recover, maybe as much as double from its sell off lows.

Step 5 – The Demise

In this stage, the stock slowly drop and keep dropping for weeks and months till all the selling dry up.

There is no more “good news” or is usually the case, no news on the stock at all.

All the stock pumpers have left the stock and they are promoting a new hot stock to new investors.

All we know, based on the pumper’s subject line, was that any chance for more gains on the stock pretty much went up in smoke the moment they came out with a new stock pick.

It is impossible to identify a pump-and-dump scheme in the first phase, but once it starts getting promoted it may be hard to miss. 

In principle, there are two ways to make money once the stock is being pumped. 

First by buying before the peak and selling ahead of the promoters, and second by selling the stock short at almost any time after it has appreciated. Both approaches have potential, but also significant risks.
 

Buying the Stock before the Peak

Buying the stock before the peak puts you in the position of trying to figure out when the scammers will stop promoting the stock and let the price crash. 

From the stock price charts, you can observe that stock pump and dump usually rally from the flat base by between 5 cents to 20 cents....some could be more of course. But you don't be greedy. You go in and out quickly with a target of 5 - 10 cents profit, and move to the next stock.

Shorting the Stock after the Peak

Shorting the stock is, in principle, simpler. If you short the stock, you are betting that the price will fall, and you know that it has to fall when the scammers stop promoting it. In practice, it isn't so simple. 

Many of the stocks promoted in pump-and-dump schemes cannot be sold short because they are too thinly traded or because of regulation like in Malaysia. 

Even if the stock can be shorted, short sales carry some unique risks: a short sale has (in theory) the potential for unlimited loss; and there's the risk that your broker might force you to buy back (cover) the stock before it falls.

Conclusion

All these ideas for profiting from pump-and-dump implicitly assume that the market for the target stock is reasonably well functioning (stock with good daily volumes, not PN17 or GN3, etc). Unfortunately, the scam artists intentionally choose companies where the stock trades very infrequently or losses making --these are the stocks which are easiest to manipulate. 

However, be warned that you are inherently at a disadvantage, since the scammers are making all the decision. If you make a wrong move, either purchasing or shorting, you could be out your entire investment.