Common Stock Market Scams Explained in Simple Language

In the stock market, many people can lose their money if they are not careful and are unaware of spreading scam tactics. Let’s understand some of the common scams explained in a way anyone can relate to.

1. Pump and Dump Scam: A group of scammers first buys a cheap stock quietly. Then, they start spreading fake news to the public at large, e.g., (a) this company will launch a new product, (b) a big investor is coming into this company. They create hype, and what happens? More people buy the stock, and as a result of the demand and supply relationship, the price rises. The scammers then sell their shares at an increased price and run away, leaving regular investors holding stock whose price quickly crashes. It’s like selling ₹10 water bottles for ₹100 by spreading fake news about a shortage. And what happens when the truth comes out? There is no one to buy, and these people incur huge losses.

2. Fake Tips Scam: This happens over WhatsApp, Telegram groups, or other social media platforms. A group of people behaves like professional stock market experts and shares tips, claiming that a company’s price will rise in 2-3 days and double. Initially, their tips seem to work, building trust among you. But in reality, they have already bought cheap shares and hold a huge stock. When a large number of people in the group start buying, prices rise due to the demand-supply relationship. The scammers secretly sell their huge stock at the increased price and earn huge profits, while innocent investors waste their money.

1. Front Running: This is done mostly by brokers. Suppose you want to invest a huge amount in stock and ask your broker to buy ₹10 crore worth of TATA Steel shares. As per the demand and supply, the huge order will push prices up, which the broker knows. He silently buys some TATA Steel shares for himself first. After he places your order and the price goes up, the broker sells his shares at a high profit. This is cheating because brokers are supposed to work for you and not earn profit by malpractice using the information they know.

2. Fake Office Setup Scam: Like shown in movies, you receive calls where someone tells you that a stock will soon double or triple in value. They act very professionally but are working out of a fake office. They push people to buy useless stocks, which creates temporary price hikes as people start buying and demand increases. The scammers sell their shareholdings at high prices and run away, leaving you with useless shares that have no value.

3. Accounting Fraud: Here, some companies showcase fake profits to appear more successful and engage in window dressing by presenting false profits in their financial reports. They hide losses, misrepresent the balance sheet on paper, and make everything look perfect, attracting investors. But when the real picture comes out, the stock price falls or crashes. A good example is the Satyam Scam in 2009, where ₹7,000 crore in fake profits were reported, fooling thousands of investors.

4. Short Selling Trap: Here, big traders bet that a stock’s price will fall. This is a type of stock trading. They spread fake bad news, e.g., bankruptcy of a company, mismanagement, or loss of a major contract by the company. Small investors start selling their holdings. As supply increases, the price falls, and the big players win the bet and make huge profits.

5. Circular Trading: A group of traders keeps buying and selling the same stock among themselves and spreads false news that the stock is very active and in demand. People notice this activity, which is fake, and start buying the stocks with the view that it will give good profit. As soon as the crowd jumps in, the scammers sell their holdings at high prices and run away, causing the price to crash and innocent people to lose their money.

6. Insider Trading: Internal management of a company uses secret information to their advantage. For example, if a company is going to incur losses in the future, insiders holding the company’s shares may sell them before the loss is declared, before the price falls, and before the public knows. Similarly, if the company is going to make a profit in the future, they may buy shares at a lower price early before the public knows and later sell them at an increased price. This illegal activity is called insider trading.

7. Churning: This tactic is used by some greedy brokers. Instead of investing smartly for you, they keep buying and selling shares in your account just to earn more brokerage fees. It looks to you like your portfolio is active and earning, but in reality, you are paying more charges. It’s like a taxi driver taking longer routes just to increase your fare.