"Actual price" is the price at which a stock is currently trading; "target price" is what somebody thinks the stock is worth or could sell for in the future. The larger the difference between the two, the more it motivates investors to act. But you have to be careful: A target price can help you make money, or it can hurt you.
Analysts often assign price targets to their stock recommendations. Their models factor in current data and future estimates to project how much a stock could be worth in the future, and to determine whether it is a buy, a hold or a sell at current levels.
Traders often set price targets for their stocks. Some use a mechanical approach, such as "I will sell when it’s up 20 percent." Some try to estimate the size of a potential move by analyzing the chart pattern and trading history, such as "I believe the stock is going to $50."
Fear and greed are the two strongest motivators in the market. Anchoring stock prices helps trigger those emotions. For example, you hear that XYZ, which is currently trading at $25, is likely to go to $28. This might not motivate you to buy because the price target is too close to the current price. But if you hear that XYZ is worth $40 and if you trust the source, you are likely to buy it now for a potential 60 percent profit. Conversely, if the XYZ you own is projected to drop to $10, you will be very motivated to sell now.
A price target from a famous analyst can become a self-fulfilling prophecy: Investors and traders will continue to buy XYZ as it is moving up, as long as the price is below the predicted $40 and they can still realize a profit. The fact that the stock is increasing in price appears to confirm the accuracy of the prediction.
The risk of relying on price targets when buying or selling stocks is that a price target is somebody’s opinion as to what a stock could or should be worth, whereas the actual price is what investors are willing to pay for the stock based on all available information. Opinions are often wrong and can change with incoming data, and you never know the motivation behind an opinion.
Price anchoring is an excellent tool for manipulation. Suppose an institution has a sizable position in XYZ at an average cost of $20 and would like to realize a 50 percent profit by driving the price to $30. It needs high volume to sell its entire position, so it puts a $40 price target on the stock to motivate others to buy. When XYZ reaches $30, the institution quietly starts selling into the strength, while others are still buying.
- FINRA Guide to Understanding Securities Analyst Recommendations
- Trading For a Living; Alexander Elder