If you go to a popular stock forum, you've probably seen often these type of posts :
Stock ALERT!!!! ABC TECH SET TO EXPLODE!
(CODE: ABCT) is about to RALLY in price as investors discover this hidden gem!
And so on....
This is the classic "pump-and-dump" stock fraud, where the fraudsters quietly load up on the stock in advance, then promote the crap out of it, hoping to drive the price higher to make a quick profit. The company itself may have nothing to do with the promoters, but just happens to be a convenient target.
Investors are well-advised to ignore these stock touts. In many cases the company itself is nearly worthless or loss making, and the price is likely to collapse as soon as the hypsters have sold their stock and stop promoting it.
But the capitalist part of me keeps thinking...isn't there some way to make money off these schemes?
How the Stock Pump and Dump Work
Next, the perpetrators begin promoting the stock through stock forums, chat rooms, Facebook posts, finance magazines, etc. Since the stock has (presumably) been chosen because it doesn't trade much and will move a lot when people start to buy or sell it, this promotion should drive the stock price up. As the stock goes up, other investors suddenly take note and start to buy, driving the price up more.
The third phase is when the scam artists start selling their stock, presumably after it has hit a price where they can make a profit on their scheme. They keep promoting the stock, since it has to stay high long enough to sell all or most of their shares.
Finally, once the fraudsters have cashed out, they stop promoting the stock. Without the hype, there are few (if any) new buyers, and the people who bought the stock find that they have nobody to sell to. The price crashes.
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 cents profit, and don't come back.
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.
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