A ‘Pump and Dump’ is essentially when the owners of a security create hype around it based on recommendations and grand exaggerations in order to inflate the price. When done correctly, the price will shoot up and the owners will try to sell at the top to the unfortunate few who have been so expertly hoodwinked. What used to be more akin to the cold-calling you may have seen in “The Wolf of Wall Street” has now evolved into message boards and social media sites, including Twitter (NYSE: TWTR), Facebook (NASDAQ: FB), and especially Reddit being flooded with posts about a specific stock and some hastily thrown together due diligence in an attempt to create momentum behind it.
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Market manipulation for the many
With the evolution of the ‘Pump and Dump’, the lines have become blurred. It is illegal to artificially inflate the price of a security for your own gain. Jordan Belfort is not the first person to be imprisoned for this kind of activity, but there is a big difference between a broker’s recommendation and an anonymous Reddit post.
Market manipulation has been rife on Wall Street since before Joe Kennedy was cheating the system. Modern times are no different. You need only look at Goldman Sachs (NYSE: GS) recent downgrade of NIO (NYSE: NIO) or the chaos currently surrounding Eastman Kodak (NYSE: KODK) to see it. The only difference is that now it is not solely perpetrated by the elite few. These online communities have recognized the power they now wield and are using it accordingly. It is no less predatory than what has preceded it and those buying at the top are just as likely to get burned, but at least there is a sense of equality to the cesspit. The haves and the have nots are playing in the mud together for the first time in Wall Street’s history.
The current pump-of-the-month is mattress company Purple Innovation (NASDAQ: PRPL), which has grown almost 30% in the past few trading days. However, a quick look at the charts of stocks like Genius Brands (NASDAQ: GNUS), Nordic American Tanker (NYSE: NAT) — and perhaps most infamously Hertz (NYSE: HTZ) — tell the tale of where this story goes.
It is not limited to penny stocks though, with companies like Microsoft (NASDAQ: MSFT), Tesla (NASDAQ: TSLA), and Peloton (NASDAQ: PTON) all being enthusiastically bet on in the form of call-options on these forums. However, with more established companies like these, the increased volume has a lesser impact on their stock price.
What can you do?
For those who are part of these communities, the FOMO is very much real as they are forced to bear witness to astronomical gains in the space of weeks, days, and sometimes even hours. Everybody wants to get rich quick, don’t they? Unfortunately, the game many of these options traders are playing is like walking a tight-rope over a safety net of hot coals while juggling flaming pins with a lion strapped to your back. Why is the lion strapped to your back? Same reason why Nikola (NASDAQ: NKLA) has a $13 billion market cap with $36,000 in revenue. Because nothing makes sense.
For every trader that makes 10x on a penny stock, there’s the person on the other side of that deal who bought it off them at the top. Instead of hopping on the bandwagon and investing in a stock because it’s going up, take a step back and actually look at the bigger picture for a second. Maybe it’s not a good idea to buy stock in a bankrupt company, or invest in a business that’s seen its valuation go up by 1,000% in the past 3 days. The number of people who lose money in these get-rich-quick schemes far outweighs the number of people who actually make it, it just might be the latter who are the loudest.
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Financial Analyst at MyWallSt
Michael's first and favorite stock is Square, which he sees becoming a massive player in the payments industry and a leader in the war on cash.