The infamous penny stock pump and dump scheme is the longest running pink sheet scheme still in practice today. This procedure for manipulating people out of their money has been run since the beginning of stock trading, but it is still difficult to control because the people who get involved choose to buy and sell the stock; they are not being forced in any way.

Since the barrier to day trading has been reduced by the advances in computers and internet availability more people are becoming addicted to trading stocks, somewhat the way people become addicted to gambling.

The newcomers to day trading are often more susceptible to manipulation because they are often following technical trading patterns laid out in books. Every professional and beginner understands these patterns, supports, and resistance points because they are available in common literature. The difference is the professional understands why these patterns form so they can sense manipulation when it rears its ugly head. The second tool the professional uses is money management so even if they are caught in the scheme they get out with minimal losses.

Here’s what the pump and dump looks like:

Penny Stock Collecting

The first part of the scheme involves the penny stock scammers collecting as much of a penny stock as possible without significantly moving the price. They often trade like scalpers, holding a portion of their trades while slowly building up a significant inventory to make the scam worthwhile. If they collect too fast they’ll send out signals that the stock is gaining momentum and the momentum traders may start buying, which will movie the price before they’ve collected enough stock to be worth their effort. This process can take weeks or even months.

Penny Stock Momentum

Now that the “investors” have collect up as much stock as they are willing to gamble with they will make a quick series of purchases to give the stock a momentum boost. They’ll usually purchase with just enough volume to get the price to cross a major threshold, either a major moving average, Fibonacci ratio, or Bollinger band. Whichever is closest will usually do. This will get the early swing traders on board encouraging them to purchase the stock, then the scammers will stop buying.

Penny Stock Marketing

Now the spamming will begin (or perhaps just prior to the momentum buying.) The internet forums, chat rooms, emails, and even phone calls will be buzzing with activity about a hot new stock. Detailed charts with pretty lines will show how the stock has just broke out and show how it is sure to hit dizzying heights. Early suckers will begin to buy in, the beginner swing traders will think they hit gold and ride the wave up. The paper profits look amazing at this point. Late coming momentum traders will bounce in and out of the rise up with the people looking to get rich quick. Everyone is happy at this point.

It All Crumbles

As the stock trading volume his its peak the scammers will dump all of their stock. There will be a temporary drop and the experienced traders will recognize the scam and dump their stock too. As no real news comes out from the company the stock will slowly dwindle with a few people who were truly investing left holding the bag wondering what went wrong.

Summary

The moral to this story is that you need to understand why you’re investing in or trading a particular stock and not simply follow someone else’s lead. If you trust others with your money you’ll more than likely end up losing money and trust. Invest with a plan, trade with a plan, experiment with a plan, and spend with a plan.