Penny stocks are typically less liquid and not having the same reporting requirements as stocks traded on major exchanges. This lack of information and liquidity make penny stocks particularly vulnerable to fraud.

One common fraud you may have heard of is Pump and Dump. In the film The Wolf of Wall Street, the protagonist Jordan Belfort robbed investors of nearly $200 million after executing a pump-and-dump scheme.

How A Pump-and-Dump Scheme Works in Stock Markets

For example, fraudsters use social media, direct email campaigns, and discussion boards to spread false or misleading information about a company in an attempt to get others to buy the company’s stock and drive up the stock price.

Once the price rises as high as the fraudsters expect, they profit by selling their own shares to unsuspecting investors, causing the stock price to collapse. Only fraudsters profit, all innocent investors lose.

Possible Signs of A Pump-and-Dump Scheme

Investors should watch for the following warning signs of “pump and dump”:

• “inside” information about a company provided through unsolicited means
• a surge in trading of a microcap company without material public news
• huge return predictions such as “1k could return 10k in 10 days”

Pump and Dump in Cryptocurrency Markets

As mentioned above, because of the lack of information, penny stocks are well-suited for pump-and-dump schemes. Well, that’s also the case in cryptocurrency markets.

The crypto industry is still largely unregulated, making it easy to issue a new cryptocurrency or token. Since the new crypto product has little intrinsic value, marketing is key. Fraudsters would gather celebrities to promote this new crypto. When the price goes up, fraudsters will coordinate the sale in order to get everyone paid.

In 2022, the US Securities and Exchange Commission said Kim Kardashian had received $250,000 for advertising EthereumMax on her Instagram page, without disclosing she had been paid to do so. The reality TV star paid a $1.26m (£1.12m) fine over this crypto pump and dump.

The Bottom Line

If you are planning to invest in UK penny stocks or other highly speculative assets, do your own research and trade carefully. Only invest money that you can afford to lose, and do not blindly follow celebrities’ recommendations.