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Investors warned over social media “pump and dump” tactics

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Taking stock tips from finfluencers? Here's why that can be dangerous.

With the rise of finfluencers, meme stocks and the retail investor, ASIC has issued a stern warning to companies, brokers and traders about their use of social media following a spike in so-called "pump and dump" strategies.

"Pump and dump" activity occurs when a person buys shares in a company and starts an organised program to seek to increase (or "pump") the share price before selling at a profit and leaving other investors in the red.

According to the regulator, it has recently observed blatant attempts to pump share prices, using posts on social media to announce a target stock, a designated time to buy and a price or percentage gain to be reached before dumping the shares.

ASIC Commissioner Cathie Armour said "ASIC has been working closely with market operators to identify and disrupt pump and dump campaigns, and we will continue to target actions that threaten the integrity of markets and to take enforcement action where appropriate.

"Market participants, as gatekeepers, should take active steps to identify and stop potential market misconduct.

"Participants should be on the lookout for groups of clients who trade in the same stock, in the same direction and around the same time," Armour warned consumers.

"They may have opened accounts at a similar time, been referred by the same person, have the same account contact details, or transfer funds between themselves."

ASIC reminds investors that market manipulation is illegal.

It can attract a fine of over $1 million and up to 15 years imprisonment. ASIC takes breaches of the market manipulation provisions seriously.

Meme stocks rise in popularity

The term meme stock came about in early 2021, when investors, mainly through Reddit's WallStreetBets, enacted a short squeeze on the market.

In the stock market, a short squeeze is a rapid increase in the price of a stock owing primarily to an excess of short selling of a stock rather than underlying fundamentals of the business.

As such, due to heightened short-selling on stocks including GameStop and AMC Entertainment Holdings, investors who bought the asset saw their profits soar in just a matter of days.

However, the relative success for a select few investors has seen the rise in social media trading, the launch of finfluencers and warnings from the watchdog about impending losses investors might face.

Despite their popularity, Superhero's co-founder and CEO John Winters notes a lack of fundamentals behind the stock could mean investors are taking on a risky proposition.

"Meme stocks are defined by the online attention they have attracted, rather than actual company performance. If the stock has already gone viral, there's also a high chance that any large gains have already occurred and the chances for large losses are high," Winters told Finder.

"Earlier this year, GameStop went from US$18 to US$480 and back to US$40 within a 4 week period. Following the crowd into meme stocks can be as risky as gambling, so be sure to do your research."

How to know if it's a good or a bad stock tip

The rise of meme stocks has also come with the rise of the finfluencer.

You've all probably heard of influencers on social media. It's much the same concept except finfluencers use social media as a platform to share advice on anything from budgeting to buying a house right though to the latest hot stock to pick.

And while the advice could be genuine, Winters issues a warning to Finder, highlighting that investors should do their own research before buying an idea heard on social media.

"Finfluencers are not licensed financial advisers and not licensed to give advice either," he reminded investors.

"That being said, finfluencer content can be a great place to start learning about market trends, how to conduct research, and they're also great for tips and tricks that more experienced investors already know," Winters said.

Belldirect's senior market analyst Jessica Amir reaffirmed this, urging investors to take a measured approach when it comes to advice from finfluencers.

"Stick to the rules of stock picking. And remember that a business is valued on its future cashflows," she said.

"You would not just buy into a shop on the street corner because it's for sale and you 'heard' it was a good investment. It might be worthwhile finding other investments that are undervalued, and that grow in value."

Can you get ahead through meme stocks?

As with any highly volatile stock, there are both winners and losers.

However, if an investor is going to purchase meme stocks, Winters notes that they should do so as part of a balanced portfolio, with more defensive assets allowing investors to offset potential losses.

"Absolutely. Diversification is key when investing and if you want to take some risk with a small part of your portfolio then go for it," he said.

"But you need to consider the effects that may have if things don't go as planned."

What you should ask before picking a stock

Amir provided a few handy hints for investors before purchasing any stocks.

Ask yourself:

  1. Is the investment in a growing industry?
  2. Is the stock/company gaining market share?
  3. Are its cashflow and earnings growing?

Using the example of the Evergrande saga and falling iron ore stocks, Amir reminds investors to always look to the future cash flows when it comes to buying stocks.

"The iron ore place has fallen 40% from its high, so iron ore stocks have fallen heavily (BHP, Rio Tinto, Fortestcue Metals), as they will be earning less money as the iron ore price has fallen and their cashflow will fall.

"So think about that and use your stock picking the same. Think about future cashflows… will they rise," Amir concluded.

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Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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