Pump-and-dump schemes are a form of market manipulation that significantly impacts penny stock prices. In these schemes, fraudsters artificially inflate the price of a low-volume penny stock (the "pump") by spreading misleading or false information, often through social media, newsletters, or other communication channels. The goal is to create hype and attract unsuspecting investors, causing the stock's price to surge.

Once the stock reaches a peak due to the increased demand, the perpetrators sell off their large holdings at a profit (the "dump"). This sudden sell-off causes the stock price to plummet, leaving the new investors with significant losses as the value of their shares rapidly declines.

Penny stocks are especially vulnerable to pump-and-dump schemes due to their low liquidity and small market capitalization. Since they trade at low volumes, even a relatively small influx of buying activity can lead to sharp price increases, making them ideal targets for manipulation.

For retail traders, the impact can be devastating, as they may unknowingly buy in at inflated prices only to watch the stock collapse. Understanding the signs of a pump-and-dump scheme, such as unrealistic price spikes or excessive promotion, is crucial for avoiding these traps in penny stock trading.