Buyer Beware: Unsolicited E-mails Sent Out by Spammers Pump Penny Stocks to Record Profits (Technorati) Technorati | (Del.icio.us) Del.icio.us | (Digg) Digg | (Blinklist) Blinklist | (Comment) Comments (2)

I personally prefer not to trade penny stocks for a couple reasons. First, my stomach does not handle that type of volatility very well. Second, these stocks are much easier to manipulate maliciously than higher priced stocks. Here is the most recent example of my point in an article written by Tyler Hamilton titled "Spammers Make a Sound Investment in Stocks - Unsolicited e-mail that touts penny stocks is on the rise and getting results".

A new study reveals that spam messages promoting stocks can make you money -- if you're the spammer.

"Hot Energy! Oil Stock!" shouts the typical message. "Ready To Run!! Big Winner!!! Huge Advertising Campaign This Week!" Such come-on messages often refer to a company with a listing on the Pink Sheets, an over-the-counter stock quotation system. They're designed to entice novice traders to buy stocks that are normally overlooked.

The article goes on to explain the "pump-and-dump" scheme, which I see so many times happening on stock message boards around the web. Here is some from the article.

These annoying campaigns are growing in frequency and volume. Sophos, a Massachusetts-based supplier of software for protecting companies and consumers from online threats, reported in July that 15 percent of all junk e-mail messages are now stock spam, up dramatically from less than 1 percent 18 months ago.

So why is stock spam on the rise -- and adapting quickly to technologies designed to stomp it out?

"It's not that it's just cheap to send, but it actually gets results," says Jonathan Zittrain, professor of Internet governance and regulation at Oxford University, and co-author of a new study, "Spam Works: Evidence from Stock Touts and Corresponding Market Activity." He's also co-founder of the Berkman Center for Internet & Society at Harvard Law School.

Stock spam uses the classic "pump-and-dump" scheme. A spammer sends out a mass e-mail message touting a penny stock with low trading volume in hopes of convincing a handful of people to buy shares of it. If the spammer succeeds, the limited buying activity boosts the stock's price and liquidity just long enough for the spammer to sell his own shares (or the shares of his client) at a profit. The stock subsequently plunges and those who bought it are usually hit with a loss.

In their study, Zittrain and co-author Laura Frieder, an assistant professor of finance at Purdue University in Indiana, sought to quantify the effectiveness of such campaigns. To do so, they analyzed more than 75,000 stock "touts" appearing in Zittrain's e-mail inbox and a Usenet spam-sighting newsgroup between January 2004 and July 2005. The date and estimated size of each spam campaign was compared with the price and trading volume of the company shares being promoted over several days, including the day immediately preceding the campaign.

The researchers discovered that if a spammer bought a stock a day before beginning heavy touting, then sold the morning after the first day of touting, the average return on investment was 4.9 percent. And more effective spammers saw a 6 percent return.

On the other hand, if a victim were to invest $1,000 in a stock on the day of heaviest touting, that investment would be worth, on average, $947.50 in the two days following the spamming campaign. For the most heavily touted stocks, the same investment would fall by 7 percent, to $930. The study also confirmed that the volume of touted stocks responded "positively and significantly" to touting campaigns, meaning that trading activity increased.

"Our analysis shows that [stock] spam works," wrote Zittrain and Frieder. "Among its millions of recipients are not only those who read it, but who also act upon it, suggesting a value to spamming that will create a powerful counterbalance to regulatory and technical efforts to contain it."

The rest of this interesting article can be read by visiting the Technology Review article. I share this article because I don't want to see anyone out there get involved, or worse lose money, in the markets because of the malicous behavior of a few. These corrupt individuals are relying on a common mistake (that I have mentioned before) that ameture investors make, investing based on emotion. It's easy to see that the spammers are simply trying to create enough hype to get you excited enough to pull the trigger on a stock you would have otherwise never had considered. Trade carefully my friends.

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2 Comments - Post your comment below.

Aug. 26, 2006

Really interesting article - and a good warning for an inexperienced investor like myself. In reading about this situation, I can't help but wonder what the history is behind this type of scam. Clearly this type of "stock advertisement" was not possible before we had high-speed internet and email spam, but were there other ways individuals would try to manipulate the market? Not knowing the laws regulating the market well, I'm assuming this type of trading is illegal - any idea what's being done to stop this type of action? Again thanks for the warning - it's a good reminder that whenever you see an advertisement relating to your money you should be critical.

Chad Lapa
Aug. 28, 2006

Hi Kate. You are right. This type of trading is definitely illegal and the Securities and Exchange Commission (SEC) are the guys who watch for suspicious trading activity. A good example was of this 15 year old boy, Jonathan Lebed, who would buy large sums of penny stocks before proceeding to hype the stock up on the Yahoo Finance message boards. Once enough people bought into (aka fell for) his hyping of the stock and pushed the price higher, Lebed would cash out and take his hefty profits. He realized more than $270,000 in profits at the tender age of 15 doing this. I was lucky enough to get $5 bucks from Grandpa at that age. His case is really interesting and is a good example of what not to do.

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