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Medical Marijuana (OTCPK:MJNA) is a penny stock that seems to have drawn quite a bit of speculative interest over the last several months. While some argue that there is a very legitimate case to go long the stock, others believe that the stock is a fraud and should be shorted to zero. While I believe that there are some serious questions that Medical Marijuana's management needs to answer in response to the short case (allegations of fraud and illegal dealings are serious), that's neither here nor there with respect to what's going on with this stock. This is all a question of stock market dynamics and it all has very little to do with the company itself.

This stock smells like a classic penny stock pump and dump. It doesn't matter to these buyers whether management is credible or not, and investors certainly don't really seem to care about whether this company generates any free cash flow (it doesn't, by the way). It's a penny stock that's been "going up" and you're seeing signs of retail investors piling in at these levels expecting to be able to cash out big.

Experienced investors have seen this before.

The Chart Doesn't Lie With Penny Stock Pump And Dumps

Everything you need to know about a penny stock that has moved several thousand percent is in the chart. This is not a stock that has any material institutional ownership, and things such as "cash flow," "earnings," and "balance sheet" mean nothing to the folks buying this stock.

The Anatomy Of A Pump And Dump

Everything you need to know is embedded in the chart, and the anatomy of a "pump and dump" is always, always the same.

(click to enlarge)

Stage I: Accumulation

So you've got a stock that, well, nobody's really aware of (seriously, when did YOU hear about this stock?). It's been trading at a couple of pennies for a while. It's forgotten, and quite frankly, nobody serious would consider it as an investment. However, some lucky folks were accumulating all of this time, waiting for the right time to start unloading shares onto enthusiastic buyers at a later date.

Stage II: An Initial Catalyst

Something happens to get buyers excited. Perhaps it is a promotional article, or maybe an upcoming event that everyone is expecting will lead to "new, big things." In this case, Medical Marijuana is going to be issuing forward guidance for the first time, and everyone's really excited at how that'll turn out.

Stage III: "Pump" And Circumstance

This is when investors start to get excited. Really excited. The stock has risen hundreds of percents, everyone's (this includes people who have never bought a share of stock in their lives) heard about this great "investment," retail's pouring all of its money in, and everyone's waiting for the finale. You see comments/messages all over the message boards about how "undervalued" this is and how it's worth 1000% more than what it's currently trading at, and so on. This is as excited as you'll ever see any retail investor in this market. They're "sure" that this stock is going to quintuple!

Stage IV: Collapse

While the giddy newbies were buying hand over, the smart guys who got in early were busy unloading their stakes to the hapless retail investor. Now, eventually the expected catalyst will come (and it looks like it'll be next week) and then the people who bought on the hype will want to start cashing out those big 1000% gains that the guys on the message boards promised. Generally, nothing within the scope of reason that management can say at this point will lead to much more than a very short-lived pop before everyone starts selling.

Now, just as a positive feedback loop turned this stock into a 10 bagger on the way back, a negative feedback loop will create a lot of bagholders. Suddenly those mysterious "pumpers" on the message boards will either disappear entirely (because many of them are now finished selling their positions for huge gains), the stock cut through critical support levels like butter, and eventually it will become clear to those new to this game that this was a pump and dump. A lot of people got rich from this (including the insiders), but the majority of the retail investors will start blaming short sellers or simply those of us who are sitting back and watching this all unfold, cringing at the fact that many retail investors will swear off the markets because it "seems like gambling."

Don't Believe Me? Here's A Finished Example

Here is a "finished example" of such a pump and dump:

(click to enlarge)

You see it all right here. Accumulation, excitement ramps on the expectation of a future catalyst, heavy bidding up to an unreasonable level, and then finally the collapse.

The stock here was BroadVision (NASDAQ:BVSN). The accumulation was likely by the "National Inflation Association" (founded and led by notorious message board pumper/dumper Jonathan Lebed). The "pump" was orchestrated by that organization (they even published an article here right when the stock topped) on promises of riches on the back of the Facebook (NASDAQ:FB) IPO (since BroadVision is an eCommerce company), and of course the collapse/dump when even the company's management had no clue as to why the share price had seen such a meteoric rise.

Conclusion

I know that it's the dream to get rich off of penny stocks. The internet is filled with ads showing some "dude" giving you a thumbs up and saying that he's a millionaire with 10 Ferraris and 20 PlayBoy bunnies servicing his every whim because of "penny stocks." If you get in early enough, and if you're lucky enough to have picked the stock that gets "pumped," then you could get rich.

But the odds are good that if you're buying after a ~1000% increase in the share price, you're the sucker who is going to be left holding the bag. Stay safe, and only speculate on these things with money that you can afford to lose.

Source: Medical Marijuana: It's Just A Pump And Dump

Additional disclosure: I do not intend to take any position in this company, so please spare me the accusations of being a "closet short".