WHAT IS A PUMP AND DUMP?
Step 1:Buy shares of a private company
Jordan Belfort would buy shares in a private company. Note: it does not necessarily have to be a private company, but it is easier to do with a private company. Think of it as trying to move a rock versus moving a boulder. Usually, a private company is a rock.
Step 2: Sell some of the shares
Jordan sells some of his shares to his clients. He makes back his original investment. However, the stock is still private. It is a private trade, known as an over-the-counter(OTC) trade. Jordan's intentions are of taking the company public.
Step 3: IPO time
Jordan takes the company public, through a process called an initial public offering (IPO). Jordan's brokers sell the stock using high-pressure tactics. The price of the stock skyrockets.
Step 4: Looks like we hit a snag
There is no such thing as infinite money. Jordan's clients and other investors are running out of money to throw at the stock. If the price is increasing, ceteris paribus, the liquidity in the market will tank.
Step 5: The hype is over
There is limited money in the market, especially for this particular asset. Therefore, people in the market start to lower their bids. At this point, Jordan sells all his stock to unsuspecting customers and his brokers make a hefty commission as well.
Step 6: hold this for me
The clients who bought the stock at such a high price level cannot sell at a higher price level. People in the market are bidding lower and lower as time progresses. The price is tanking since Jordan sold all his shares. Ignoring any exogenous condition, Jordan Belfort has most of the liquid cash, but he will not invest it into the stock anymore. The clients are left with a bad stock.
Note: we assume continuous time