IPOs have taken the Indian Secondary markets on a roller-coaster ride. Every few days, a new IPO makes big moves in the market, flexing sizable oversubscriptions from investors and being listed at hefty premiums. Companies are rushing to go public and if we were to talk numbers, at the time of writing this article, 59 IPOs have been listed on the mainboard, whereas, SME Board has boasted 191 IPOs so far. The average subscription rate for all these IPOs so far has been 208 times and the total issue size has been nearly โน90000 crores.
The recently listed Bajaj Housing Finance opened at an impressive premium of 114%, breaking several records. With such notable events happening in the IPO scene, investors often overlook a common trap when it comes to price manipulation- Pump and Dump which is what this article is all about.
Here's a video on Understanding the High Stakes Game of Pump and Dump!!
What is a Pump and Dump scheme?
Ever wonder how some random unfamiliar companyโs stock prices suddenly shoots up overnight? What you witnessed is a Pump and Dump scheme in action. This is not just limited to just IPOs but can also be observed in listed stocks.
In this scheme, the price of a security is inflated artificially through unwarranted information or hype. This attracts a large number of investors who end up buying the shares, spiking the demand and thus, the share prices (pump). Once the prices hit highs, the perpetrators sell all their holdings (dump) and book their profits. This sudden selling causes the prices to tumble down and any new investors will suffer losses from the falling prices. 
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Let us take an example to visualize the scheme
What we see in this chart could be classified as a pump and dump scheme. This stock โXโ was listed at around โน34. But over the course of the next few months, the prices skyrocketed to achieve a high of โน392 (pump). But soon after that, we can see a very sharp decline (dump) in the next few months after which, there are some signs of consolidation. Nevertheless, the stock continues to slide, ending up lower than the listing price itself, ending up at around โน23.
How does the โPumpโ work?
There are several ways in which schemers โpumpโ up the stock prices. The most common and obvious one is spreading misinformation. Often, the bad actors create hyped up content which is spread all over social media platforms and other mediums. The content contains a lot of buzzwords, appealing numbers and aims at creating a sense of โFOMO, i.e, missing out on a golden opportunityโ. This ends up creating a sense of urgency and jealousy in unsuspecting investors who, then, buy into the bait and make poor investment decisions based on emotions.ย
This just ends up benefiting the schemers who already have a lot of stake at the company that they are falsely promoting. The rising demand from the market, caused by gullible investors, drives up the stock prices which benefits the schemers.
How does the โDumpโ work?
Aggressive publicity surrounding the stock ends up driving the prices high which is where the schemers collectively decide to sell their stake. This ends up causing a dip in the stock prices and all the investors who bought the shares due to the built-up hype may end up suffering losses. A massive crash in the prices also ends up affecting the liquidity and volumes of the company. Further, the company may also incurr financial losses and damage the companyโs image. There have also been instances where the stock prices drop so low that the company ends up pulling out of the stock market altogether.ย
One such example is that of Bre X Miners, a Canadian mining company. In 1997, there were reports of them finding a huge gold reserve in Indonesia which drove the prices through the ceiling. Soon after, it turned out to be false information which caused the company to lose billions of dollars. Eventually, the stock prices dropped so low that they became worthless. The company got delisted and later filed for bankruptcy. It became one of the biggest scandals in Canadian history and the biggest mining scandal in the world.
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The effect on shareholders
The problem with such schemes is that most people who are not that well-versed in stock markets buy into the hype created. Often, there is a sudden jump in the prices, which is caused artificially. Seeing this, the naive investors further get tempted and the schemers can use the โWe told youโ phrase to manipulate more and more people into investing. But within a few weeks, the stock suddenly dips inprice,s and the shareholders end up losing a lot of money. This may induce a fear of stock markets and trust issues too if the losses are substantial, thus discouraging them from further calculated investing.
Legality?
Under the guidelines of the Securities Exchange Board of India, the propagation of pump-and-dump schemes is illegal and is subject to hefty fines and penalties. Nevertheless, the practice is prominent since many players brush it off as advising or stating their opinion to the open market, which is completely legal. Thus, this matter treads on a fine line of legality, which makes it difficult for market regulators to distinguish between sharing opinions and manipulating. Pinpointing bad players and holding them accountable becomes difficult.
But one such case of Pump and Dump which was neutralized by SEBI, was the case of Arshad Warsi and his wife Maria Goretti. They were accused by SEBI of manipulating stock prices by working with a Nexus of investors to promote misleading videos on YouTube about two companies. This spread of false information led to inflation of the stock prices of the two companies and the schemers offloaded their shares for profits (nearly 50 crores), affecting unsuspecting investors.
This begs the question,ย
How can investors navigate such schemes?
Firstly, caution is of the utmost importance. Thereโs a saying that goes โNever trust anyone who is more interested in your success than yourself.โ True to the saying, if one gets a suggestion or a newsletter or any information of this nature, investors should try to understand what exactly they are really trying to convey. Itโs always a good rule of thumb to not buy into such instances unless one understands the reasoning and the logic behind these tips. But this does not mean that one cannot pick up such stocks and take advantage of such opportunities.ย
As long as investors have a trading strategy and are vigilant, they are absolutely free to pick up such โpump and dumpโ stocks. Suppose a company โRST ltd.โ is generating a lot of hype in the market and thereโs news about it all over the place. One can trade the shares of RST ltd. if the charts and fundamentals look appealing to the investor.ย
They could participate in the pump but will have to keep an exit plan ready. Something like selling the holding periodically, setting a target and a stop-loss. The only thing that the investor needs to be mindful of is that the shares are overpriced and are very likely to start selling off soon. Thus,
In Conclusion
While pump-and-dump schemes may create the illusion of opportunity, they are inherently designed to exploit uninformed investors. Awareness, research, and caution are key to navigating such market manipulations. Investors should always critically evaluate stock recommendations, stay wary of overhyped opportunities, and have a clear exit strategy. By maintaining a disciplined approach, one can minimize losses and avoid falling victim to these fraudulent practices, ultimately fostering a healthier investment mindset in the stock market.
Also Read: What is Swing Trading vs. Day Trading? A Comparative Analysis
