The classic Pump and Dump is a well known scam used by promoters to try to make unsuspecting investors part with their money. What one does not hear that much about is the stock scam of making money off the fall of a stock price. Around the investment water cooler, this is sometimes referred to as the Short and Distort. The Short refers to short selling, that is, the selling of stock by an investor who does not own the stock that he or she is selling.

We have set out below, the various stages of the Short and Distort.

Phase 1: Research.
The short and distort player will look for stocks that might be overvalued.

Phase 2: Short Sell.
When there is a bit of activity on a stock due to news, the short seller comes into the market and sells short (sells stock that he doesn't own).

Phase 3: Rumour Mill.
Unlike the scamster in the Pump and Dump, the scamster will now engage in a campaign to undermine the worth of the stock is shorted by spreading rumour. This can be done by negative posts to message boards, chat rooms, newsgroups, issuance of newsletters recommending the sale of the stock, etc. This plan of distortion is aimed on enticing investors to dump their stock with the prime objective of driving the price down. Instead of excitement, the distorter tries to stimulate fear.

Phase 4: The Cover.
Now that the price is falling, the distorted must buy stock to cover his or her position. The distorter buys the stock at a discount thereby making his profit. In order to create a selling frenzy which the distorted must do in order to buy enough stock to cover his position and not drive the price up in the interim (thereby minimizing his profits) he will create the impression that there is a great deal of selling taking place. He will do this by having his friends and brokers cross stock to each other giving the impression of large volume.

Phase 5: The Loss.
The buyer who initially bought the stock at elevated prices, sold at lower prices on the mistaken belief that the stock was worthless based on the distortion campaign.

There are variations to the Short and Distort scam. A promoter of a worthless stock could artificially inflate a stock price of a thinly traded stock and then promote the stock and sell short. Then without news the stock would drop back down to original levels at which point, the promoter covers his position at a profit. The promoter could Pump and Dump and then Short and Distort and every year continue the cycle.

The underlying theme is stock manipulation by a person who is ultimately trying to make money off the backs of unsuspecting investors.

What can you do?

If you purchase and stock and you see that it is falling, don't panic. Check the fundamentals of the stock and if nothing has changed, there might not be a reason to sell. Call your broker for more information as to why he or she feels the stock is falling. It might be a good opportunity to average down.