What is a pump and dump?

According to investor.gov,

"Pump and dump" schemes have two parts. In the first, promoters try to boost the price of a stock, typically in a microcap company, with false or misleading statements about the company. Once the stock price has been pumped up, the promoters seek to profit by selling their own holdings of the stock, dumping shares into the market, which typically causes the stock price to collapse.

While this is true, this definition is incomplete. For one, the purpose of the promotion is not solely to raise the stock price. Often the people paying for the promotion are insiders or investors who were compensated by the company with shares at a fraction the current market value. Because of this, their interest is merely to create volume to sell into since selling at any price would provide them with a handsome profit.

The important thing to understand though is that the people being paid to promote the stock are biased by the compensation. Their motivation is to paint the picture of a healthy company worth buying into. Thus, their claims can be exaggerated, misleading, or just plain lies. If you are ever advised to invest in a company, closely inspect the communication for some sort of disclaimer that may indicate the person has been compensated. Often times, this disclaimer appears at the bottom of emails.

Since the purpose of the promotion is to sell shares, there will be a constant downward pressure on the stock price. In the beginning of the promotion though there are usually enough enthusiastic buyers to counteract this selling to cause the price to rise. Once this hype and excitement wares off, the stock price usually falls dramatically. Often, such promotions occur on bulletin board exchanges where there is less liquidity. As a result, it is difficult to sell out of these stocks once they begin to show signs of weakness making them a dangerous investment even if you are aware that it is a pump and dump.

The safest way to play pump and dumps is to buy at the very beginning of the pump if you know the promoter has a solid track record of raising stock prices. The time you hold that stock should relate to your level of risk tolerance. Selling quickly for smaller gains is the least risky strategy and is a good way to build a small account. Holding the stock longer may allow for larger gains but it also presents the risk of large losses due to the difficulty of exiting just before and during a crash. Such a strategy should only be performed by more experienced traders who understand the risks at hand.

A sample promotion email:

GWBU closed green on Friday with a gain of 3.50%. This week could be very significant after one week of being relatively flat.We believe GWBU could be ready to break $2.00 in the very short-term and potentially reach $10.00 or more as predicted by a recent Seekingalpha Analyst.If the Analyst's prediction is achieved, members could be looking at over 800% in gains.Let's look at the TOP 10 Reasons why everyone should consider GWBU before it is too late!#1- According to the company, GWBU focused on developing technologies that reduce fuel consumption by as much as 15% and cut emission by over 70%. This is a technology in huge demand around the world.#2- Just in the States alone there is over 250 million vehicles that could use this technology to reduce fuel consumption and emission. Globally we are talking over 800 million vehicles that could potentially use GWBU's technology.#3-Currently, the global clean-tech market is estimated at $284 Billion and is projected to grow to more than $1.3 Trillion by 2017. Start Technologies Europe I.G.’s technology (GWBU) increases energy efficiency, reduces pollution and is applicable on a global scale.#4- ELASIS Research Centre( part of FIAT Group, 6th largest automaker in the world) worked with GWBU in the past.
Results showed emission reduction by over 40% and fuel consumption by over 10% on a 2003 FIAT Scudo. (see the full report here: http://www.starttechnologiescorp.com/technology/research-reports/)#5- GWBU recently announced contracts that could be worth over $50 million USD. Could there be more contracts on the way?#6- A recent positive test with the Transport Ministry of Barbados showed that GWBU's technology increase fuel efficiency by 20% and significantly cut emission. More evidence that the company's technology is working!#7-  Recent Analyst stated that "majors like Ford, Chevy, and Dodge could be interested in GWBU's technology!" This interest could significantly increase the value of the company in the future.#8- After a week of consolidation, we think GWBU is ready to make a move North. We've seen this in the past, and we believe history will repeat itself very soon!#9- The Reg sho on GWBU shows over 10 million shares in short volume just in the last few weeks. A major short squeeze could propel GWBU much higher!#10- If GWBU can replicate our last pick's percentage gains it would soar to
around $10 in the coming weeks!At these levels, we think GWBU could be a steal and we urge our members to start looking into the company.Sincerely,The Free Investment Report Team

And the associated disclaimer:

(Note the $100,000 expected payment in the final paragraph)