Avoid Pump-and-Dump Penny Stocks with This Strategy

By Diane Alter, Contributing Writer, Money Morning • August 4, 2015

Many investors continue to fall victim to pump-and-dump penny stocks - but this strategy will help any investor avoid this common penny stock trap.

Pump-and-dump penny stock scams are typically created by professional marketers working in cahoots with micro-cap companies and/or dishonest brokers. The aim always the same: to make money off unsuspecting investors' honest trades.

Here's how the pump-and-dump penny stock scheme works...

How Pump-and-Dump Penny Stocks Work

It's common to see messages posted on the Internet urging readers to buy a stock quickly.

Telemarketers often robocall - automatically and repeatedly call investors with a computerized message - to deliver their pitch. These promoters frequently claim to have "inside" information about an impending development, or they claim to use an "infallible" combination of economic and stock market data to select winning stocks poised to soar.

The truth is, these individuals are likely company insiders or paid promoters who want to create heavy buying interest and pump up the share price of a stock they own. Then they'll sell their shares for a hefty profit. Once these cons sell (dump) their shares and stop touting the stock, the price falls. And investors lose money.

Pump-and-dump investors can also short a stock and then create a marketing campaign urging investors to sell the security before it crashes. This way, they are profiting from the stock's fall.

Now there's a new way that pump-and-dump scammers are operating...

The Latest Variation of the "Pump-and-Dump" Scheme

A number of people are finding they've received a "misdialed" call from a stranger who leaves a "hot" investment tip for a friend. The message is designed to sound as if the speaker didn't realize that he/she was leaving the hot tip on the wrong answering machine.

A message like this is not a wrong number. Instead, it's from someone paid to leave these messages on scores of answering machines.

In addition to these dishonest tactics, be aware that when a new product or service is grabbing headlines, professional con artists will try a pump-and-dump scheme.

But you can avoid a pump-and-dump penny stock scam with this one simple strategy...

How to Avoid the Penny Stock "Pump-and-Dump" Scam

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• A penny stock plugged via mass emails, Internet sites, snail mail, and phone calls hyped as a "Strong Buy" that could make a fortune for investors who get in early is a red flag.
• Only talk to and follow the advice and/or guidance of a reputable financial advisor from a respectable firm. Approach any investment with the same kind of research and concern you would when selecting a doctor.
• Make sure you understand a company's business, product, or service.
• Find out whether the company has registered its securities with the U.S. Securities and Exchange Commission or your state's securities regulators.
• Sketchy financials are always a red flag.
• Be suspect of stocks trading on the Pink Sheets. Pink Sheets is a daily publication of bid-ask stock quotations for companies unable or unwilling, for one reason or another, to be listed on a major, national exchange.
• Look at the plugged stock's movement over the last several months. If a micro-cap company's shares have recently surged on heavy volume absent any substantial news, that's almost always a sign to proceed with caution - or avoid.
• Suspicious connections are also a sign of a pump-and-dump scheme. Check out the people running the company with your state securities regulator. Also ask whether the people running the company have had run-ins with the regulators or other investors. An Internet search will usually uncover invaluable information.

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Related Articles:

• U.S. Securities and Exchange Commission: Micro-Cap Stock: A Guide for Investors