The finance industry contains a lot of money and that does unfortunately attract a lot of scammers that want to separate investors from their hard earned money. Many scams are easy to spot if you do your homework and avoid everything that seems to good to be true. Other scams can be very hard to spot. Bernie Maddoff is a good example of this. In retrospect he might have been delivering results that were a bit too good and too stable to be true but he was big enough and respected enough to make it all believable. As an investor you had no reason to doubt him.
On this page we are going to look more at a number of common scams and what you can do to avoid getting scammed.
The stock tips scam
The stock tips scam is a classic scam that has been around for a very long time. People used to use personally addressed letters to perform this scam but now a days it is more common that email is used. Email is more cost effective and allows you to contact a lot more people at the same time. The basic premise of the stock tip scam is that you want to make your intended marks believe that you can predict the market. You to this by sending letters to a large group of people.
You send two letters. One say that stock A is going to go down. The other says that Stock A will go up. One of these letters will be right. You then send another two letters to the group of people who got the correct prediction in letter 1. You will one again tell half the recipients that a stock will go up and half that it will go down. Half the group will once again end up getting the correct advice. They have now received the correct stock tips from you two times in the row. You repeat the process a few more times until you have a group of people that have received a number of correct predictions. This group is a lot smaller then the one you started with but contain a lot of people that hopefully will believe that you can predict the market.
You will then pitch a stock tips service to them that they have to pay for. The scammer hopes that enough people will chose to buy the worthless service to make his work worth the effort. A variation of this scam is that the scammer pitches to become your stock broker and ask you to open a trading account with a certain company and deposit money. The company is often a scam and the scammer runs of with your money.
How to avoid this scam. Simple never believe that anyone can predict the market perfectly and never do business with a company or individual that contacts you without you first soliciting information from them.
The boilerroom scam
The boilerroom scam is similar to the stock tip scam but in this case there will be a smooth talking “broker” that contacts you and suggest trades that are going to make you rich. The individual in question wants to become your broker. He usually recommends a penny stock. If you check the penny stock you will often see that the stock do indeed exist and that has been going up lately. This is due to the fact that the boilerroom team have been pumping it up. If you accept the offer then the broker will indeed buy the stock for you but they will do so from stock that they already own and that they bought cheap before they started pumping it.
The stock might continue to go up for a while and the broker might even contact you to buy more. But sooner or later the boilerroom will move on to a new stock after dumping all their stock on unsuspecting clients. When this happens and they no longer pump the stock price then the price of the stock will fall very quickly and you will end up with worthless stock.
It can be profitable to trade on this information by yourself but if you do you need to know that it a high risk trade and it is very important that you sell your stock before the boilerroom finish their pump and dump scheme. You need to exit before they do.
To avoid this scheme you should make sure to never do business based on a phone call. Ask the person to send you more information and if they do send some then you should investigate the company well. Be advised that these boilerroom changes name often. It is therefore unlikely that you will find a lot of dirt on them. A better way to find out more about them is to see how long they have been in business. Always check how long the domain has been registered and do a search in Wayback machine to see how old their website is and how it used to look.
Pump and dump scams
Pump and dump scams are scams where people buy a cheap penny stock and then try to inflate the price. (Could be any stock but penny stocks are most common). This can be a part of a boilerroom operation where people actively sells the stock to investors. A more common approach is however that a person ( or group) buys a lot of shares over an extended period to make sure he gets a good price. Once he has bought the stock he wants for the scam he starts to buy more stock in a more aggressive way. In a way that gets the stock price to go up. It usually doesn’t take much to inflate the price of a penny stock with little trading and little interest. It can often be easy to inflate the price 10-30 percent in a day or even more. At the same time the pump and dump artist start talking about the stock in different forums, on facebook etc.
They talk a lot of the potential, posting fake news and rumors etc. the scammer often have a lot of pre-written texts available to make sure that everything is convincing and that he can post a seemingly well done analysis etc. He will all the time point to the stock market and how he is right since the stock is rising. He will keep posting and manipulating the stock price for several day. At this point he will start to attract people who are believing him and that are buying the stock. They want a piece of the pie. This will cause the stock to rise even faster. At this point the scammer can stop buying shares and keep the hype alive by simple posting about the stock. There will usually be a lot of other people talking about the stock. Once the stock reaches the scammers goal price he will start selling slowly. Slow enough that the price keeps going up. Once he have sold a certain percentage of his stocks he will start dumping the rest on the market a lot faster.
He will have made a large profit. It is not unusual the stock keeps going up for a day or two after this. The demand for the stock will however sooner or later diminish. When this happens the stock price will fall quickly. Within soon it will be back where it started. At the true value of the stock.
A pump and dump scam is a great opportunity to make money if you can spot it but you need to get in and out quickly so that you do not get caught in the fall. Do not be be greedy and never keep your stock more then a day or two.
The best way to stay to avoid these scams is to stay skeptical to stocks that skyrockets for seemingly no reason. Or to simply invest in high quality blue chip stocks instead of chasing a dream.
Some more brazen scammers will put out fake PR releases from the company to the media to manipulate the stock price.
More scams will be posted soon