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How to Avoid Pump-and-Dump Stocks

Updated on April 27, 2015

The Sell

The stock market can be a dark and dangerous alley to wander into. Without knowing what you are doing there, you can easily lose all your money in a matter of minutes. I was lucky but I can't say that for a lot of investors who did not get out in time.

It started with an email that arrived on a Sunday night that talked about a startup company that had an exclusive agreement a manufacturer in China to distribute bamboo based toilet paper and paper towels. I looked up the stock and found several impressive press releases that reported they had acquired key personnel from Walgreens and CVS to help manage their marketing and distribution efforts. I decided to watch the stock for a few days before buying any shares. In the next few days, I would get more excited as they were receiving purchase orders from stores across America that I trusted. Stores such as Cardena's, Walgreens, CVS, Rite Aid and more. As these press releases were accumulating, the stock price steadily rose. I grew more and more agitated because I wasn't on the cash train.

On Wednesday night, I received another email telling me a summary of what the company had accomplished in the short time frame and how well the stock had performed. The volume of shares trading between parties went ballistic. People were jumping in and buying into the trend. On top of that, I liked the organic benefits of bamboo on the environment and the sustainability of the product. Instead of thrashing our diminishing tree forest, why not grow bamboo to make paper products that we flush down our toilets?

It all felt right so I put in an order on Thursday morning. I bought $5,000.00 worth of a penny stock and I was going to double it in a week.

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Great fortunes for stock traders
Great fortunes for stock traders

The Dream

After putting $5,000.00 down on a penny stock that up to now had lived up to expectations, I was nervous. I was constantly looking things up and re-reading the press releases. I kept scanning the internet for scams and seeing if this company made the news. I checked the directors of the company to see if they had a criminal background or if they served time in a prison for fraud. Fortunately or unfortunately, it was clear.

Perhaps, the dream will come true and I will double my money. I would love that to happen but I have invested $10,000.00. The greed kicks in.

Save up and buy a BMW
Save up and buy a BMW

What would you do with $10,000.00?

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The Sting

By Friday, the stock price had risen to a level that no one had expected. The emails said the stock will double but with the volume of shares trading, it was not going to stop there. The company was going to step up its marketing efforts outside of California. They were going east and all the way to Florida.

When the market was about to close on Friday, I was tempted to sell my shares. I was sitting on a profit of $4,000.00 and thought it was enough stress that I was putting myself through. I was not sleeping well and I was constantly worried about my investment. I decided to put it off until Monday and see what happens.

The weekend was uneventful. I kept my research going and could not find any writeup on the company, other than analysis from TheStreet or Seeking Alpha to stay away from this stock. I have trusted these sources before but they sometimes contradicts themselves. The problem is that they have so many analysts that write for them and everyone has their own opinion. One analyst may recommend a stock while another would tell you to stay clear of it. Depending on when you read the article, you may buy it then later told to sell it, resulting to a loss. I've gone down that road too many times before.

When Monday morning arrived, I checked the stock price and noticed a downward trend. I watched it for a few minutes and it was clearly on the downturn. The stock was losing money fast and the volume of shares increased. Something was up but I was too busy, refreshing the screen and seeing the stock spiral down.

I quickly looked up the news and saw that someone was reporting a 'Pump-and-Dump' scheme involving this stock. I didn't know at the time what this meant but I was concerned about my money. I signed on to my brokerage account and put in a sell. The stock was losing ground so fast that I sold my shares at market price. I really did not have the time to put in an ask price. It was changing too fast and in a matter of seconds, the stock was down 10 cents then 20 cents. Investors were dumping the stock because they were had and I was part of the mess.

By the time the stock was under $1, I was in the clear. I was scared to see the sell price but when the smoke cleared, I realized I made $2,000.00. If I wasn't greedy before the weekend, I could have made $4,000.00 but it was no use dreaming of what I could have had.

I was lucky to have sold my shares at the start of the dump. Other investors did not hear of the news until the end of Monday. By then, the stock was almost worthless.

Pump and dump schemes are considered illegal by the Securities and Exchange Commission.

Have you experienced a Pump-and-Dump scheme?

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My Advice

All 'Pump-and-Dump' schemes work the same way. A stock is pumped up by promising news. People buy the stock and the volume skyrockets. When the securities board detects fraudulent activities, it tries to notify law enforcement and the people pumping the stock flees. The news slowly percolates through the market and people starts dumping the stock. The scheme is exposed and the stock becomes worthless.

After almost getting burned in a Pump-and-Dump scheme, I now ignore all suspicious emails that smell like a stock pump. I'm not a bit curious and I don't want to be tempted anymore. It is best to ignore emails like this.

If you're playing the stock market or plan to play it, pick up a few good books on investing and reading them. A lot of my friends follow Warren Buffett and I follow Jim Cramer.


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