What Is a Pump-And-Dump Scheme, and Why Is It so Evil?

pump and dump

Stocks go up and down all the time for all sorts of reasons. Apple, for instance, is at an all-time high because their sales turned around, beat expectations, and show that people will pretty much buy anything made by Apple. Cocoa stocks (yes, stocks that follow the chocolate market) are down because there’s a cocoa surplus. While supply and demand determine whether or not a stock goes up or down, many factors can affect investor demand and supply.

Sometimes, however, nefarious investors out for their own gain can affect demand in less-than legal ways. In 2011, a false Tweet claiming that then-president Barack Obama had died caused the stock market to crash for a short time. Though the market went back up again, this short crash allowed traders and investors to buy stock at rock-bottom prices.

A more common scheme to influence stocks, however, is the ever-famous “pump-and-dump” scheme. As depicted in movies like The Wolf of Wall Street and Boiler Room, this illegal and morally bankrupt scheme sees an investor (or investors) misleading other investors with false information about a stock to jack up demand. The “evil” investors will then dump the stock they bought for more than it was worth, hence “pump-and-dump.”

One Minute Economics recently released a video to explain how this scam works. After all, if you can recognize a pump-and-dump scam in action, you can save yourself from losing a whole lot of money.

How can you avoid a pump-and-dump scheme? First, never let a broker or brokerage pressure you into buying a security before you do your research on it. Second, if something sounds too good to be true, it probably is. Last but not least, if someone claims to have a “hot tip,” whether they’re a broker or a friend, they’re probably full of it.