Breakdown of a Pump and Dump:
A pump and dump scheme involves a stock being boosted to unjustifiable price levels based on false or misleading statements. First, the offending party establishes their position in a stock and subsequently promotes it to as many people as possible. This promotion brings in additional buyers, which “pumps” the stock to higher levels, at which point the perpetrators sell out of their positions for gains. And since the rise in price was caused by exaggerated remarks and hype, the higher price levels are completely unsubstantiated, and as a result a “dump” ensues. The stock price will typically crash back down to pre-pump levels and sometimes flush even further.
Uninformed traders and investors are often the victims of such schemes, which is why it’s extremely important to be educated on Wall Street. These pump and dumps certainly take place throughout the market, but they tend to have the highest impact on small cap, low float stocks that are extremely susceptible to manipulation – it doesn’t take a lot of buyers to drive prices up substantially. Because such schemes exist, it’s extremely important for individuals not to simply chase “hot picks” or blindly mirror the buying/selling of anyone else. Education is king on Wall Street for a reason – not only to protect your portfolio from losses but to capture gains as well.