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What's a "pump and dump" OTCBB stock?

I received an email from some company promoting a publicly traded stock that's valued at $0.17/share. How can stocks be that low and is there any chance it's a legit offer? Or is this stuff all a big hustle?


Dave's Answer:

Let's start out by having me translate your question: I got some spam. Is it legit?

As you can tell, the answer is "probably not". In fact, you should probably just delete the message and run away immediately from the offer because it's the tip of a very peculiar iceberg called "Penny Stocks", or, more formally the OTCBB or Over the Counter Bulletin Board. Basically, it's where companies that have a stock value of less than a few dollars/share but are still publicly traded go to either die or, hopefully, get their act back together and raise their per-share price back up so they can be on the NYSE or NASDAQ or similar.

The problem is, there are also a lot of shenanigans that happen with penny stocks, and that's what you're seeing with the kind of email you get. At $0.09/share, for example, you can drop $500 in and get a ton of shares. Then if it goes up even $0.05/share and you sell it, you can ostensibly make a quick profit.

Even if the reason it went up is that you promoted it without any real basis.

Which is exactly what you're seeing. There's a name for it in the business: pump and dump.

The idea is exactly what you'd think: someone purchases a block of stock in one of these companies then artificially promotes the stock through email, newsletters, Web sites, and perhaps even paid advertisements. Others learn about it and decide that at such a low cost-per-share (certainly compared to blue chip stocks like Apple and Google, for example), why not take a chance and pick up $50 worth?

Problem is, every time a stock is sold the price drops and every time a stock is purchased it goes up (well, generally speaking). So if the original investor picks up a bunch of stock then a group of other people come along and over the next few days also purchase shares, the per-share price will increase simply because of the transactions, without the company actually being "worth" more or having announced any big new contracts or signed a partnership, or released a new product or anything at all.

At that point, the original investor sells their block of shares and by doing so drops the market value down, often below their original purchase price. Which means that the other investors are kinda stuck. They bought $500 at $0.23/share and watch in horror as it drops down to $0.06/share rather than leap up to $0.50/share or higher.

See how that works? And so when you get an email like this:

otcbb

You can now unwind what they're saying and understand the carefully worded pitch. "The stock ran from $0.12 to $0.25 with a 100% gain". But what did the company itself do to justify a doubling in market value (which is what is happening when the stock doubles)? The answer is probably nothing at all. The increase in value is based on market manipulation, and that's what this con is all about, carefully packaged in the guise of a financial newsletter.

Reality is, the only way to know that a stock is going to go up is to study the company. When there's no information about the company itself or some nonsense about "poised to release new products" or "announce a breakthru in", then it's clearly bogus. Otherwise there's another problem called insider trading and if the newsletter editor is being tipped off by an employee that something new is poised to break, then they can both go to jail. So why would they share?

In fact, that's the key question to ask: if the stock is going to double, why would they want us to buy a single share? Why not buy up every available share and reap the benefit against the greatest possible initial investment? Because in fact the whole thing fails unless lots of clueless chumps mindlessly jump in and buy the stock without doing their research so that they can avoid the "scramble for shares".

So there's a long answer to a simple question. If it's not a legit company, if there's no logical reason the stock should be poised to rise, if there's some nonsense about breakthru announcements or similar, I'd delete the message and move smartly along. Real companies don't pre-release info, real companies are actually quite difficult to predict in the market, which is why investing is fraught with risk.

Good luck and be skeptical!


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Categorized: d) None of the Above   (Article 10650, Written by )
Tagged: nasdaq, nyse, otc bulletin board, otcbb, penny stocks, pink sheet, pump and dump, stock scams
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Reader Comments To Date: 1

Billy Bob said, on February 18, 2013 3:14 PM:

Asker should check out the movie "Boiler Room." It's about a bunch of guys trying to get rich with a similar scheme. Very fun to watch. The most amazing part is Vin Diesel playing a stock broker instead of an action hero.

Starbucks coffee cup I do have a lot to say, and questions of my own for that matter, but first I'd like to say thank you, Dave, for all your helpful information by buying you a cup of coffee!

I do have a comment, now that you mention it!











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