How to protect yourself from stock market frauds and scams

As a market participant you should always stay away from stock market frauds and scams. If you fall into the trap, it can cause a lot of damage to your investments and financial goals.

The best way to protect yourself from any stock market fraud and scams is to avoid it.

In this article, we will tell you how as an individual investor or trader you can protect yourself from any stock market frauds and scams.

What is stock market frauds and scams

Market participants invest or trade in the stock market to make money. 

Some market participants are so greedy that they fall into any kind of get-rich-quick tips and suggestions. They don’t do their own research before investing.

Some fraudsters try to get these greedy investors and traders to their network using different types of methods such as by sending unsolicited emails, SMS and calls.

When certain investors and traders fall into the trap, these fraudsters make money either by selling or buying stocks. You can also be asked to transfer a certain amount of money to their account in order to get stock market tips.

Below in this article we have discussed certain types of stock market frauds and scams these fraudsters are using and how you can avoid them.

Avoid Unsolicited Calls, SMS and Emails

You need to be very careful about phone calls, email and SMS received out of the blue for investing in stocks, bonds and mutual funds.

These people are so good at pitching their right objective, that you will not be in a position to think before putting your money into it. By the way, it’s not investing, if you go by these unsolicited calls, SMS and email, it means you are speculating.

What is the chance of getting your money back? Who knows, what will be the outcome.

Many Times we have seen SMS from unknown sources to buy a particular stock within a price range to double or triple your money. Beginners are the one who fall into this kind of trap. After getting into their scam, people who already positioned themselves, sell their stocks to make profit leaving you behind with a huge loss. This technique is known as pump-and-dump scheme.

Pump-and-Dump Schemes – One the most popular stock market frauds

In pump-and-dump schemes, scamsters play with two of the most effective overworked emotions in the financial market: greed and fear.

Here are the normal steps followed in a pump-and-dump scheme;

  • Scamsters try to promote a particular stock as a hot investment which can give multiple returns. In general, they select stocks from the Penny stocks, small-cap and mid-cap category. They promote by sending emails, phone calls or SMS. This is the first step where they activate the pump.
  • Due to their superb marketing strategy, few market participants start buying the stock. Due to high demand, the share price goes up.
  • After seeing the price move up to their expectation, these scamsters sell their stocks at a higher price. The dump is complete. 

If you are victim of a pump-and-dump scheme, you will be left with huge loss as there will not be any buyer at your price.

How to avoid a pump-and-dump scheme? Very simple, avoid such unsolicited phone calls, emails and SMS.

Don’t invest in a business you don’t understand

World famous value investor Warren Buffett says, “you should invest in companies that you both understand and believe will offer long-term value”.

Here are a few more quotes by Warren Buffett;

  • You have to learn how to value businesses and know the ones that are within your circle of competence and the ones that are outside.
  • Never Invest In Something You Don’t Understand
  • To invest for the long term, the company must be run by able and honest managers, and available at a sensible price.

If you don’t understand a business, then don’t invest in it. Many beginners fall into what analysts are saying about the stock without understanding the business the company runs. Due to which, they are unable to track the impact on the stock due to economy and market movements.

Therefore, invest in a company within your circle of competence. If you don’t understand, then better to invest in the stock market through mutual funds. Avoid stock market tips and suggestions which you don’t understand.

Short-and-Abort – One of the Popular Stock Market trading scams

In one of our earlier articles we have discussed short selling, which is also referred to as going short.

In short selling;

  • Investors with the help of their margin account ask his broker to go short on a stock. 
  • If the broker agrees, then they either from their own inventory or from a client’s inventory get the required number of stock and sell them in open market at current market price to obtain money.
  • Brokers lend the money to the investor who wants to go short.
  • As the transaction is based on borrowed stock, sooner or later the investor has to return the stock. Therefore, the investor whenever opportunity arises, buys the number of stocks that the broker originally sold to generate money and return it to the broker. Then, asks the broker to close out the position.

Such a strategy is adopted when the investor thinks that the stock price will fall.

In short-and-abort, scammers create fake stories and use their marketing strategy to create concern and panic over a company’s prospects. 

Due to which, many market participants decide to sell. 

Due to the market fall, at this stage, scamsters close their short selling position at a lower price due. They easily take the money from other market participants and run away.

Beware of fake or unrealistic investment tips

Many experts you will find in the stock market giving investing tips as a part of their get-rich-quick scheme. Few of them also offer expensive seminars and research reports to make money for you with no effort. Be aware about those unrealistic investment tips.

When you see any kind of get-rich-quick stock market tips on the internet, consider it a scam until you prove it’s legitimate through your own research. Gain sufficient knowledge and do your own research before investing in the share market.

If you are a beginner, the best way to invest in the stock market is through mutual funds or by taking help from a professional financial expert.

Here are some of the world famous stock market frauds and scams where companies betrayed their investors;

  • Enron
  • Worldcom
  • Healthsouth
  • Bernard Madoff
  • Centennial Technologies
  • Satyam

You might have also heard about the Harshad Mehta scam and the Ketan Parekh Scam. We will cover these frauds and scams in our upcoming articles.

By learning how to value a business and knowing the companies that are within your circle of competence, can help you to understand the stock market and through your own research you can start investing. 

If you are a beginner or new to the market, you can take a mutual fund route to invest in the stock market. You can even take help of a financial expert to guide you in investing in stocks.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.