# Understanding Pump-and-Dump Schemes: Definition, Illegality, and Types

## What Is Pump-and-Dump?

Pump-and-dump schemes manipulate stock prices through false hype and are illegal under securities law. Historically conducted via cold calling, these schemes now thrive online, targeting micro- and small-cap stocks. With the rise of cryptocurrencies, pump-and-dump tactics have expanded into this unregulated space, making it crucial for investors to recognize the signs and protect their investments.

### Key Takeaways

*   Pump-and-dump schemes are illegal, manipulative tactics used to artificially inflate the price of a stock or security, then sell it for a profit.
*   These schemes historically targeted micro- and small-cap stocks due to their low regulation, but have increasingly infiltrated the cryptocurrency market.
*   The advent of the internet and social media has made it easier for fraudsters to spread false information rapidly and target investors with unsolicited pitches.
*   To avoid falling victim, investors should be wary of unsolicited offers and conduct thorough research and due diligence before making any investment decisions.
*   The SEC and CFTC offer guidance and incentives to protect against these scams, including financial rewards for whistleblowers revealing pump-and-dump activities.

![Pump-and-Dump: Illegally boosting a security's price through false, misleading, or greatly exaggerated statements to make a quick profit.](https://www.investopedia.com/thmb/y7YJBcu6Y00OZZQDeRTIFLTihDk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Pumpanddump_final-01bad4984f454742b2a17da3a71dad86.png)

*— Investopedia / Michela Buttignol*

## Understanding Pump-and-Dump Schemes

Pump-and-dump schemes used to rely on cold calling, but now fraudsters send mass emails or post online to lure investors quickly.

The messages often claim to have insider info about a coming event that will boost the stock price. Once buyers jump in and the stock has moved up significantly, the perpetrators of the pump-and-dump scheme sell their shares. When share volume is high, the stock price drops sharply, leading to significant investor losses.

Pump-and-dump schemes generally target micro- and small-cap stocks on [over-the-counter](https://www.investopedia.com/terms/o/otc.asp) exchanges that are less regulated than traditional exchanges. Micro-cap stocks—and occasionally, small-cap stocks—are favored for this type of abusive activity because they are easier to manipulate. Micro-cap stocks often have few shares, low trading volume, and limited company details. As a result, it does not take a lot of new buyers to push a stock much higher.

## How Modern Technology Fuels Pump-and-Dump Schemes

The same scheme can be perpetrated by anyone with access to an online trading account and the ability to convince other investors to buy a stock that is supposedly "ready to take off." The schemer can get the action going by buying heavily into a stock that trades on [low volume](https://www.investopedia.com/articles/active-trading/051415/risks-trading-lowvolume-stocks.asp), which usually pumps up the price.

The price action induces other investors to buy heavily, pumping the share price even higher. At any point when the perpetrator feels the buying pressure is ready to fall off, they can dump their shares for a big profit.

## Portrayal of Pump-and-Dump Schemes in Popular Media

Pump-and-dump schemes are central to movies like "Boiler Room" and "The Wolf of Wall Street." Both of these movies featured a warehouse full of telemarketing stockbrokers pitching [penny stocks](https://www.investopedia.com/terms/p/pennystock.asp). In each case, the brokerage firm was a [market maker](https://www.investopedia.com/terms/m/marketmaker.asp) and held a large volume of shares in companies with highly questionable prospects. The firms' leaders incentivized their brokers with high commissions and bonuses for placing the stock in as many customer accounts as possible. In doing so, the brokers were [pumping up the price](https://www.investopedia.com/terms/d/daisychain.asp) through huge volume selling.

Once the selling volume reached critical mass with no more buyers, the firm dumped its shares for a huge profit. This drove the stock price down, often below the original selling price, resulting in big losses for the customers because they could not sell their shares in time.

## Strategies to Safeguard Against Pump-and-Dump Schemes

The [Securities and Exchange Commission](https://www.investopedia.com/terms/s/sec.asp) (SEC) has some tips to help avoid becoming a victim of a pump-and-dump scheme. Here are some points to keep in mind:

### Be Extremely Wary of Unsolicited Investment Offers

Exercise extreme caution if you receive an unsolicited communication regarding an "investment opportunity." Dubious investment pitches can reach you through email, social media, messages, calls, or voicemail. Ignore such messages; acting on them may result in significant losses rather than the massive gains promised by the scammers.

### Watch for Clear Warning Signs

Does the purported investment sound too good to be true? Does it promise huge "guaranteed" returns? Are you pressured to buy right now, before the stock takes off? These are all common tactics used by stock touts and unscrupulous promoters and should be viewed as red flags by investors.

### Look Out for Affinity Fraud

[Affinity fraud](https://www.investopedia.com/terms/a/affinityfraud.asp) refers to investment scams that prey upon members of identifiable groups, such as religious or ethnic communities, aging adults, or professional groups. An investment pitch from a member of a group that you are affiliated with may lead you to believe in its credibility; the problem is that the member may have been unwittingly fooled into believing that an investment is legitimate (when in reality, it is just a scam).

### Conduct Your Own Research and Due Diligence

Before you invest your hard-earned money, conduct your own research and due diligence. It is fairly easy to obtain a wealth of information online about legitimate companies—from their business prospects and management to their financial statements. The lack of such information can often be a red flag in itself.

## Pump-and-Dump Schemes in the Cryptocurrency Market

The cryptocurrency market has become the newest arena for pump-and-dump schemes. The massive gains made by Bitcoin and Ethereum have kindled tremendous interest in cryptocurrencies of every stripe. Unfortunately, cryptocurrencies are particularly well-suited for pump-and-dump schemes because of the lack of regulation in the cryptocurrency market, its opaqueness, and the technical complexity of cryptocurrencies.

A study conducted in 2018 examined the prevalence of pump-and-dump schemes in the cryptocurrency market. Researchers identified more than 3,400 such schemes over the course of just six months, observing two group-messaging platforms popular with cryptocurrency investors.

In March 2021, the U.S. Commodity Futures Trading Commission (CFTC) advised customers to avoid pump-and-dump schemes that can occur in thinly traded or new cryptocurrencies. The CFTC also unveiled a program that would make any [whistleblower](https://www.investopedia.com/terms/w/whistleblower.asp) eligible for a monetary reward of between 10% and 30%, as long as they reveal original enforcement action that leads to monetary sanctions of $1 million or more against a pump-and-dump scheme.

## The Bottom Line

The pump-and-dump scheme remains a significant threat in the financial markets, particularly for micro- and small-cap stocks and cryptocurrency. This illegal practice involves artificially inflating the price of an asset through false or misleading statements to sell once prices rise, leaving uninformed investors with significant losses when the bubble bursts.

Investors can protect themselves by being wary of unsolicited investment offers, recognizing red flags such as guaranteed high returns, understanding affinity fraud risks, and conducting thorough research and due diligence. The rise of pump-and-dump schemes in the cryptocurrency market demonstrates the importance of vigilance and informed decision-making in any investment strategy.

> **Article Sources**
>
> 1.  Investor.gov. "[Investor Alert—Don’t Trade on Pump-And-Dump Stock Emails](https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-53)."
>     
> 2.  Investor.gov. "[Updated Investor Alert: Social Media and Investing - Avoiding Fraud](https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/updated-11)."
>     
> 3.  SSRN. "[Cryptocurrency Pump-and-Dump Schemes](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3267041)," Download PDF, Page 12.
>     
> 4.  Commodity Futures Trading Commission. "[Customer Advisory: Beware Virtual Currency Pump-and-Dump Schemes](https://www.cftc.gov/sites/default/files/idc/groups/public/@customerprotection/documents/file/customeradvisory_pumpdump0218.pdf)."