Blog : Pump and Dump Works, So Watch Out!

by Ed Zwirn on May 2nd, 2013

Penny stock investors have long been the target of unscrupulous spammers who bombard prospective buyers with emails touting a particular stock and cash in on the interest generated by the touts. They offer their unsolicited penny stock "advice" for free, but have their own profit motives.

We have often spoken about this type of "pump and dump" scheme in this space. In fact, at Leeds Analysis we make our money directly through subscriptions and give our clients a  100% guarantee that all of our research is unbiased. We don't take stakes in the penny stocks we recommend and make a living selling expertise, not the stocks themselves.

Laura Frieder of Purdue University and Johnathan Zittrain of  Harvard Law School looked at a large sample of stocks listed on Pink Sheets and compared them to a large sample (75,415) of spam emails touting penny stocks and found that particular stocks being pumped up experienced significantly higher returns in the two days before heavy touting via spam email. These penny stocks were 70% likely to hit the sample's most-active list on the day they were being plugged, as opposed to a 4% probability of the stock's being active on a normal day.

For those touted stocks that were being heavily touted, a pump and dumper who buys a penny stock the day before unleashing his spam and then sells it when the touting is heaviest will earn 4.29% before transaction costs, Frieder and Zittrain reported.

For the suckers who buy the same penny stock based on these emails, the results are of course correspondingly worse, with the average investor who buys a stock when it is being most heavily plugged and sells it two days after this noise dies down losing 5.5% before brokerage fees.

"The evidence suggests not only that some investors actually do respond to spam stock touts, but they respond in ways that affect the overall market for the comparatively illiquid stocks that are the favorites of spammers," they write. "The returns rise with the initial touts and then fall immediately after."

"Overall, our analysis shows that spam works," they conclude. "Among its millions of recipients are not only those who read it, but also act upon it, suggesting a value to spamming that will create a powerful counterbalance to regulatory and technical efforts to contain it."