Spotting Pump and Dump Schemes: How to Avoid Manipulative Trading

Avoid Crypto Pump and Dump Schemes

In the fast-paced world of crypto trading and investing, pump and dump schemes persist as a sinister blight. Smart investors, aware of these machinations, find success guarding their portfolios by mastering the art of recognizing common fraudulent patterns. Holding this knowledge is a critical risk-mitigation mechanism, protecting against the potential losses inflicted by such schemes.

Pump and dump operations can have severe repercussions for unsuspecting investors. Typically, the orchestrators of the scheme will accumulate a cryptocurrency at a low price (or create their own), then artificially inflate its value through misleading or false information. Once the market price peaks, they sell their shares at this elevated price, leading to a precipitous crash that leaves other investors holding worthless tokens, commonly referred to as “holding the bag.” This sharp rise and fall often occur over a very short time period, making it a high-stakes scenario for market participants. This not only results in financial harm to individuals but also undermines confidence in the markets and can lead to broader implications in the crypto market.

Recognize Unusual Trading Activity

One of the most telling signs of a pump and dump scheme involves an abnormal increase in trading volume and token price without any corresponding news or fundamental improvements from the company. Typically, this can be seen in a token that has been relatively quiet for an extended period. When traders spot an unexpected high volume of trades coupled with sharp price increases, be cautious as this may be the perpetrators of pump and dump schemes accumulating their initial position that they will later use to recognize a gain. Monitoring trading volume can be done through most trading platforms and websites like CoinMarketCap, which provide tools for analyzing token charts and volume indicators. 

Analyze Promotional Material Critically

Promotional emails, social media posts, or newsletters that promise guaranteed returns or insider information should be scrutinized. If you receive unsolicited investment advice hyping up a particular token, this is a major red flag. Be wary of language that suggests urgent action is needed, and always question the motivation behind the promotion. A legitimate investment in a cryptocurrency won’t require rushed decisions. Research these promotions to check for misleading or false information. Confirm the legitimacy of the claims by cross-referencing with official company releases and filings. Many pump and dump schemes rely on convincing investors to act quickly on false or exaggerated claims.

Use Caution with Brand New & Microcap Tokens

Brand new and microcap tokens are particularly vulnerable to pump and dump schemes due to their low prices and lower trading volumes, which allow manipulators to more easily influence the token price. 

As ChangeNOW spokesperson Chase Fisher cautions, “It’s human nature to want to be an early participant in the ‘next big thing’ or the ‘next bitcoin.’ As difficult as it can be to fight that urge, it’s important to exercise caution. Jumping into a project with little information available amounts to little more than gambling.”

Always perform thorough due diligence when looking into these projects. Although there are not financial reports available like when you’re investing in a stock, there are other signals to look at, like whether a company has fake followers on their social media accounts, and shows signs of real operations (including employees on LinkedIn and elsewhere).

Check the Source’s Track Record

Before taking stock tips or investment advice, consider the track record of the source. Have they been right in the past? Do they have a history of promoting questionable crypto projects? Research any individual or company offering advice using independent sources. Look for reviews, previous predictions, and the credibility of their recommendations. Do not base your investment decisions solely on the guidance of promoters, especially if their history is short, non-transparent, or includes previous involvement in pump and dump schemes.

Maintain a Healthy Skepticism

Healthy skepticism is crucial in the investment world. Never take information at face value without conducting your own investigation. Whether it’s an unexpected trading tip from a discussion forum or a bold claim on social media, verify the facts before reacting. 

This is another paramount piece of advice offered by Chase Fisher of ChangeNOW: “If an opportunity seems too good to be true, it often is. Critical thinking and due diligence is crucial. This mindset will not only help you spot manipulative trading schemes but also help foster smarter, more informed investment practices overall.”

Avoiding Problematic Projects Has Impacts Beyond Your Wallet

Those who perpetrate crypto pump and dump schemes rely on market complexity, human nature related to misinformation and hype (“FOMO”), and inherent latency in detection to pull off their scheme – and your exposure as an investor could extend beyond repercussions for your wallet. 

Not only can investors suffer significant financial losses, but there can also be legal consequences for individuals who unwittingly propagate the scheme by selling off their shares during the “dump” phase. This creates a climate of fear and uncertainty where the risk of legal entanglement may discourage investors from participating in market opportunities, thereby impacting the overall liquidity and health of financial markets. Many of the largest names in crypto have been dragged into legal dilemmas over (alleged) money laundering or market manipulation, including former Binance CEO Changpeng Zhao who is expected to serve 15 months in federal prison. If big names like Zhao are facing harsh consequences for these things that go wrong, so can you.

Above all: be careful.