In Finance, what is Pump and Dump?

Pump and dump is the name that is used to identify a specific type of scheme to artificially inflate the value of a specific stock. The process involves sharing information that is deliberately misleading, greatly overstated, or is outright false. Once the information has begun to increase interest in the stock, and thus increase the purchase price, the originators of the pump and dump sell off their shares at the higher price. Considered illegal in most places around the world, schemes of this type of subject to heavy fines as well as the possibility for civil and criminal actions against the perpetrators.

Word of mouth is extremely important in the setup of a traditional pump and dump. In order to create a situation where the originators of the stock fraud maintain a relatively low profile, the process normally calls for tips to be spread from one person to another, with no one knowing exactly where the tip originated. As the information begins to be accepted as fact by some investors, the interest generated in the stock offering begins to have an impact on the unit price. In highly organized schemes, it is not unusual to make use of a cold calling approach, with stock promoters spreading the word to a wide range of investors.

Today, the Internet is also often used as the vehicle for a pump and dump scheme. This can include the establishment of web sites that feature the doctored information, and entice investors to jump at the chance to buy the shares while there is still time. Usually, the information about the site owners is either intentionally vague or uses a business name and location that is outside the jurisdiction of the authorities. In other situations, email campaigns are implemented, effectively creating a steady steam of pump and dump spam. Once the perpetrator has sold off his or her shares at the inflated price, the web sites are taken down and the email addresses used to send the spam emails are deactivated, making it hard for the average investor to trace them back to any one individual.

Many pump and dump schemes focus on stock options that are somewhat low profile. This makes it easier to spread the misinformation about the options without anyone questioning the veracity of the statements. Penny stocks are sometimes the target of this type of activity, along with other types of micro-cap stock options.

While the seller of the shares of stock will usually earn a tidy sum from a pump and dump scheme, the investors who purchased the shares rarely receive a return for their efforts. Once the scheme is completed, the value of the shares drops to previous levels, causing the buyers to lose money on the transaction. Unless authorities are able to identify the originator of the scheme and take legal action, the potential for recovering any of the loss is extremely small.