In Stock Trading, what is Pump and Dump?

Pump and dump is a form of stock fraud in which people artificially inflate the price of stock in order to profit. It is most commonly used to target microcap stocks and penny stocks, stocks in companies with a low value, because the prices of such stocks are very easy to manipulate, and their prices are notoriously volatile, so consumers expect some irregularity in these types of stocks. In most nations, pumping and dumping is illegal, and the perpetrators can face fines or prison time.

Stocks targeted by pump and dump schemes are sometimes called “chop stocks.” In the scheme, a group of people who own stock in the company begin to quietly spread misleading statements about the stock's future performance, suggesting that prices are going to rise. They may use coldcalling, unsolicited e-mail, and Internet message boards to suggest that they are in the know about the company's future, and that they are sharing information confidentially, leading people to believe that they are getting a great deal.

In response to the misinformation, innocent investors start to buy the stock, driving the price up. When the price appears to have peaked, the fraudsters dump their stock, walking away with a profit and leading the price to fall dramatically. Innocent investors can lose substantial amounts in a pump and dump scheme, especially since inexperienced investors often fail to diversify, sinking all their assets into a single stock and therefore being at risk of losing everything.

Pump and dump fraud is sometimes referred to as hype and dump. It is a definite risk, especially for people who are not experienced in the investment world. Researching stocks before purchase is critical, to confirm that they really are sound buys, as is diversification to protect one's stock portfolio. People who are not experienced may want to use the services of a brokerage firm or mutual fund which can handle their assets, while people who want to learn more about stock trading may want to practice by monitoring stock prices over an extended period to see whether or not theoretical buys would have paid off.

If someone approaches an individual investor with a claim that he or she has inside information, this is definitely illegal, and it should be reported. If the individual is lying, he or she is probably participating in a pump and dump scheme, and if the individual is not lying, he or she could be subjected to insider trading charges. Publicly-available information in financial magazines and the financial pages of newspapers is usually the best source of information about stocks.