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How Pump and Dump Works
Pump and Dump is a term to describe stock manipulation in the microcap market. Traders buy a stock at a cheap price and then trying to pump up the stock price by giving out false positive statements and news of the company so that they can sell the stock at a much higher price.
Once the the operators of these Pump and Dump scheme sold the shares of these over value stocks, the stock will fall due to high volume of selling pressure. The small retailer traders are the ones who will get hurt the most as they buy and hold their cheap stock hoping the stock will turn direction and go back up. Unfortunately, that rarely happens.
These scheme are not possible with high volume mid cap and large cap stock because in order to drive up the share price, they will need much more capitals.
Pump and Dump Stocks
If you trade microcap stocks, you need to be really careful because they are very risky. Pump and Dump happens pretty often and sometimes a stock will be investigated for fraud and manipulation. When you buy penny stocks, you have to keep in mind that you are speculating, you are not investing. Therefore, you must set a target and stop loss for all the stocks you buy. Penny stocks can rise quickly and they fall even quicker. Once they fall, 90% of these penny stocks will never recover. Many traders fall in the trap of trying to buy stocks at cheap.
For example, the stock EGLE went from $3.5 per share to over $9.5 per share in one month, that is almost a 300% gain. Does the fundamental really change for the company in less than 1 month? I don't think so. That means something might be wrong with the stock, and the stock could be a Pump and Dump. Many short sellers will short the stock and hoping the stock will drop. Indeed, EGLE did drop and went down to $3.5 again. Now, there are traders who missed the trend the first time, and they would think $3.5 is a cheap price to get in, so they bought it only to see the stock went below $3. These traders don't have a stop loss and they are just so stubborn to take a loss that they turn a small loss into a big one, and a big loss into a disaster which ruin their whole portfolio. Then they blame on bad luck. What these traders don't realize is that it is not bad luck, it is bad trading. When you buy a stock like EGLE, you have to keep in mind that you are trading and not investing. If the stock does bounce back, then you get a nice ride and profit from the trade. If the stock trend go against you, you must sell the stock and cut your loss quickly.
How to trade Pump and Dump Stocks
The right way to trade these penny stocks is that you need to be disciplined, consistent and patient. Remember, 90% of penny stocks are crap and you know that you cannot hold them for long term investment. Your goal is to get in and get out as quickly as you can. When a stock gets pump up and then dump, 90% of them will never recover because the operator of the pump and dump already left the trade and there are no interest in the stock. Therefore, you want to either get in on the Pump or try to short the stock after the stock gets pump to a price that is way over value. Either way, you have to set tight stop loss so you don't get killed on any stock.
The best strategy for Pump and Dump is to use a break out strategy. If a stock is trading below $3 for a long time with low volume, and then one day the stock break $3 with big volume, that's when you should jump in. There is a good chance that this stock will go higher and you can make a good profit. However, of the stock fall below $3, you should sell the stock and cut your loss quickly.
Check out this post to learn more about break out stocks.
To learn how to trade stocks and profit in the stock market, the first thing you need to learn is how to read a candlestick chart.