How to Spot Investment Scams

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Don’t fall victim to an investment scam. It is easier than you think for crooks to con you out of your hard-earned money if you let your guard down. Investment scams come in many forms, and they've been around for as long as stocks have traded on Wall Street, but the internet has made it even easier for these vultures to feed on investors tempted by the possibility of an “inside deal.” These scams range from crude and clumsy to highly polished and sophisticated.

Sophisticated scammers wrap their con games in an air of legitimacy, so it may be hard to see the truth, but knowing a few red flags to look out for can help protect your money.

Recognizing Scams

There are many different types of scams floating around the internet, so it would be impossible to identify them all. Even if one could detail each scam out there today, a new one will pop up tomorrow. However, there are some signs you can look for:

Promises of an "inside" deal from a stranger: If someone you don't know offers you exclusive access to sensitive information, try to consider what this person has to gain. Why would a stranger pick you out to make rich? Does that make any sense?

Fool-proof, money-back guarantees of trading systems: Traders have countless tools at their disposal to help pick stocks. It's natural for the people who create these tools and strategies to advertise them as the best available. However, when these systems are advertised as fool-proof ways to get rich quick, it's time to proceed with caution. If such a sure-fire, easy-to-use system truly existed, do you really think you'd find out about it through a personal offer? Legitimate trading tools always remind traders of the risks involved with investing. They would never guarantee returns.

Complicated schemes involving unusual securities or foreign entities: While foreign investments are a common part of portfolio diversification, these investments should be made in established companies with clear business plans. It all goes back to the common saying, "invest in what you know." Complicated plots involving offshore banks and industries you hardly know anything about should raise red flags. Why get involved in a complicated scheme you don’t understand? If you don't understand the investment, how do you know you'll earn a profit from it? Stick to opportunities that you can understand. If you're eager to invest abroad, you can explore foreign ETFs through established firms while you research foreign markets more thoroughly.

A Popular Scam Example

One of the most popular stock schemes is called “pump and dump.” Schemers buy up a block of stock in a little-known company, preferably one with a buzzword-loaded name that seizes on trends. In 2019, those buzzwords could be related to areas like cannabis, crypto, or tech. With the buzzword stock in hand, the schemers begin flooding the internet with false rumors about how this company is on the verge of a breakthrough or merger.

In some cases, company insiders actively participate in spreading these false rumors. In other cases, the company has no idea the scheme is happening, and in effect, becomes another victim. Sophisticated scammers may even develop a phony letterhead and use it to send out press releases about the company.

If the scheme is successful, and unsuspecting investors are convinced that they're getting in on the ground floor of the next big stock, the stock’s price will jump. As the stock price rises, the scammers try to decide when they think they've pushed the scheme as far as it can go. Once they've reached that point, they sell their original block of stocks, pocketing a sizable profit in the process. After that, the scammers will seek out another company to pump and dump.

Of course, after they've sold off the huge chunk of stocks and stopped spreading falsely positive rumors about the company, the company's value will plummet. Anyone still holding the stock will likely lose most of their money, but the scammers don't care, because they've already turned a profit and moved on.

This scheme can also be executed by shorting a stock. In that case, the scammers would short the stock, then flood the internet with negative rumors. When the stock drops, the short sellers cover their positions for a big profit.

The Bottom Line

With all of these schemes, the easiest way to protect yourself is to act slowly and research the investment opportunity through a variety of sources. When you see a story online about a company, look at who wrote it and where it was published. If it isn't being covered by a mainstream financial news outlet, ask yourself why that's the case. If an opportunity promises sure-fire returns, take extra time to research the company, the market, and the broader economy.

Schemes come in many forms, but they all have one thing in common: the promise of very high returns. The sad truth is that many people fall for these schemes because their greed overcomes their reason. Don’t let this happen to you. If an investment opportunity sounds too good to be true, it probably is.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.