Remember the LORD for it is he who gives you the ability to produce wealth and so confirms his covenant... Deut. 8:18

Thursday, November 27, 2008

The Games Traders Play: Pump & Dump

Market volume is very significant in short-term trading. The relationship between price and volume provides a guide to the type of buying or selling activity that is developing.

We kick off by looking at the games traders play.
Traders and investors are constantly playing games in the market. Market volume is a record of such activities. Careful analysis of the relationship between price and volume tells us which game is in play. You keep score by calculating the difference between your entry price and your exit price. What games are out there?

Pump & Dump: This is where desperate individuals play bully with a small stock and use small volume trades to push up price. This price rise is irresistible to other traders and they buy in the hope the price rise will continue. They are tagged when the price manipulator pulls out of the market.
Hide and Seek: This is when an investor tries to build a large position in a stock without causing the price to rise.
Catch that Rally: This is when investors capture a short burst of activity in a fast moving rally that, if traded correctly, can deliver good short-term profits for low risk before the rally retreats or moves sideways.
Pass the Parcel: The game starts with volume based on rumor. The aim of this game is not to be left holding the stock when the rumor is either confirmed or dismissed in the market.

This column details the share manipulation game of Pump & Dump. Here, the manipulator buys a significant volume of shares. Others see the price movement and join the rally. The manipulator then sells to these new buyers and captures a quick profit. The price is 'pumped up' and then the shares are 'dumped' or sold to unsuspecting buyers.

Pump and Dump = Recognition Rules
· Stock has a history of very low trading volume (refer the corresponding charts)
· Volume suddenly increases dramatically and is often associated with just a few trades during the day.
· Price increases by 10% or more
· Very fast price rise is associated with sudden very high volume

· There is no news event that might explain the price rise
· Gap up activity is often followed the next day by a fall in price

Trading rules
· Buy when the price begins to increase on day one. Use intraday charts to identify opportunity
· Sell on day two or day three of the price move
Recognizing the correct price and volume relationship allows traders to make a better decision about the best trading or investment approach to use for the trade.

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