Why some clients ignore your advice on suspect stocks

New research shines a light on high-risk strategy

Why some clients ignore your advice on suspect stocks
Steve Randall
While there will always be cases of innocent – sometimes naïve – investors losing money from fraudulent schemes, a new study suggests there is another reason some chose to ignore your advice. 

Researchers from Booth School of Business at the University of Chicago among others, have considered why some people shun the experts, and often their own intuition, and invest in highly suspect stocks.

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They found that, even when investors suspect that prices may have been manipulated, they are attracted to the risky investment because of the chance they could win big.

Just like playing the lottery, these investors knowingly take the risk, rather than being duped into a fraudulent investment.

"We identify several distinct types of investors, some of which should not be viewed as falling prey to these frauds," the researchers say in the paper. "For these investors, speculation or gambling are more likely to be the motive."

Pump and dump
The practice of artificially inflating stock prices through false and misleading positive advice, known as pump and dump, was the basis for the working paper "Who Falls Prey to the Wolf of Wall Street? Investor Participation in Market Manipulation.”

The study looked at 421 pump-and-dumps between 2002 and 2015, based on data from the Germany regulatory authority and the trading records of more than 110,000 individual investors in Germany.

Of these investors, 6,569 individuals (almost 6%) took part in pump-and-dump schemes, investing an average 11.4% of their portfolio's overall value and sustaining an average loss of nearly 30%.

Who’s most at risk?
The investors who were most likely to make an investment in the pump-and-dump were older, married males, not living in a big city, who identified themselves as having a high risk factor.

Those in blue-collar jobs or self-employed were more likely to take the risk.

However, the research acknowledges that past behaviour suggests many investors in these schemes were day-trading in penny stocks or were frequent traders with short-term horizons, taking substantial risks and trading aggressively before they participated in the schemes.

The full report can be accessed at chicagobooth.edu