If you invest in direct stocks or mutual funds, I am sure you would have received tons of unsolicited bulk SMS with texts like hot stock tip, next multibagger stock pick, sure-shot bet, double your money in 15 days, insider information, 100% accurate stock tips, etc.
No doubt unsuspecting investors at times get lured with the idea of quick gains and invest their hard-earned money in such tips. But most often than not, they end up losing money. There are countless examples of how these fraudulent SMS stock tips circulating everywhere try the well-known pump-and-dump strategy to rig stock prices and make illegal profits and cause losses to small investors.
I came across an interesting tweet (link) that simulated how penny stocks are rigged and people end up losing money. I am replicating a version of the text from the tweet below with some changes (to increase understanding and brevity):
How penny stocks are rigged In India?
- Select a dead stock of a small company from a booming sector with very low market capitalization.
- Meet the promoter of the company. Convince him to invest for 3X returns in a year.
- The current market price of the stock is Rs 5. Start buying from the open secondary market and thereby increase demand for the share.
- The current market price of the stock is Rs 7. Due to increased buying, it is Upper Circuit every day.
- The current market price of the stock is Rs 10. The circuit opens.
- Circulate some bad news for a short panic. Many investors will exit.
- The current market price of the stock is Rs 8. The company clarifies that all is well and investors have nothing to worry about. The stock zooms. The current market price of the stock is Rs 12 now.
- Time for Quarterly results (which may have been tampered with obviously). Sales shoot up, Profit & EPS increase too.
- The stock is now undervalued at the current market price of Rs 15.
- The Promoter comes on TV. The current market price rises to Rs 20.
- Brokerage firms start making projections. The current market price is Rs 25.
- The company announces dividend for the first time. Even a small Rs 0.10 (or 10 paise) will do the trick.
- Now comes the time to lure common investors like you.
- SMS/WhatsApp/Telegram and all other social media channels are filled with noise that the fair value of the stock is Rs 30.
- The public gets excited and jumps in.
- There is no supply in the market as the operator has already bought a large chunk over the last few months. This leads to a series of consecutive Upper Circuits. The current market price is Rs 40.
- The stock is now hailed as a potential new multibagger that everyone was waiting for! The current market price moves up to Rs 50 and beyond.
- The exit of insiders/operators begins. They start selling from Rs 50 to Rs 35.
- This is followed by bad quarterly results. Stock tanks and starts falling.
- Operators get more than 3X in 1 year. Search for new pump-and-dump stock begins again!
- As for investors, you already know what they end up with.
A captivating account of how it’s done, isn’t it?
And that is how prices of small stocks are rigged and investors are taken for a ride.
You might ask as to what the authorities are doing to handle this. SEBI does its bit by barring/banning entities who operate in such a manner. But due to the sheer number of such frauds in our country, at times it becomes difficult to take them on all at once for the regulator too.
And this type of penny stock price rigging isn’t new.
A report in Mint (link) also suggests that many big players might be involved in this and this rigging is being used at times to launder black money to the tunes of thousands and thousands of crores as well. As per the article, here is how the scam worked: “so-called operators help issue penny stocks – either in the secondary market or through a preferential allotment – to entities wanting to launder money. This stock is issued at very low prices. Then, the operators rig the price of the stock through their associates. After a year has passed (thus making any profits exempt from long-term capital gains tax), the operators accept cash from the original allottee and route it to shell firms. These paper companies then buy the stock from the allottee, helping launder black money into white.”
So does it mean that all Stock Tips in India are Scams and Fraud?
Probably yes. I know it’s a strong statement to make but I think that’s true.
If you think about it, then if you are a stock tip provider who is so sure about his picks, then instead of investing or trading in it, will you go out and allow others to profit from it for a fee? You won’t. And even if you do, it would be to help create the demand (as detailed in the earlier example) to rig the price in your favor. Right?
So no matter how you see it, it’s basically a scam. They may call it with other names and at times, associate words like 100% accurate tips or guaranteed returns, etc. But it’s all an eyewash!
Basically, these stock tip providers are price manipulators. They use various mediums to share tips (at times free during the last leg of demand creation) of the stock they have already loaded up with, to increase its demand and price and eventually, give them a good exit.
Some such SMS stock tip providers nowadays try to lure people towards futures and options. This can be disastrous. These are far more complex products than direct stock investing and if you don’t understand options, then don’t trade them even if someone is asking you to do it for sure 100% profits!
Time and again, SEBI has cautioned the general public against trading on the basis of unsolicited tips received through SMS and calls. You can read this latest warning from SEBI against investing in stock tip SMSs here.
To ensure you get reliable investment advice, the regulator has asked the public to deal with only SEBI-Registered Investment Advisers (RIA) and Research Analysts and not to deal with unregistered entities who are known to defraud investors.
If you really want to invest in direct stocks, then invest some time and increase your knowledge to pick stocks on your own. But if you are unable to do so, then it’s best to take the mutual fund route to invest in stock markets. You can create a solid mutual fund portfolio easily and that would be the best approach to generate long-term inflation-beating returns for your portfolio.
That was about fraud SMS stock tips and how ‘pump and dump’ scams in India destroy investor’s wealth. There are still many pump and dump stocks today that are being manipulated. So just be careful and ignore all the stock tip SMS messages and calls that you get regularly.
And please do yourself a favor the next time you receive any such unsolicited SMS or calls giving free stock tips for sure shot 100% accurate profits. Just delete the SMS and block the caller/sender!
Excellent article for a new investor or a trader.