Wednesday, April 6, 2011

The Paper Tiger of Paper Losses

Let me begin with an example written by an Anonymous poster way back on Cold's blog on Opportunity Cost:

Let's try a thought experiment. Say hypnotic dust currently sells for 100g per stack on the AH. Your friend decides to quit WoW and gifts you 1000 stacks of dust before he deletes his account. Did you just gain 100kg? Can you sell all of that dust at 100g per stack before the price depreciates? Let's assume that every crafted item you can make using dust values dust at less than 100g per stack, and the demand is such that I can only sell 10 stacks a day at the 100g price point. It's going to take me 100 days to sell that entire stockpile. Is a stack of dust going to retain its 100g value by the end of those 100 days (fwiw, on my server, dust is selling for roughly 50% of what it was 1.5 months ago)? If I can sell 30 stacks a day at 95g (either through undercutting or crafting or some combination of the two) is there value in paying that 5g per stack so that I can move everything in 1/3rd of the time?

Now instead of a friend gifting you the dust, let's say you can generate 10 stacks a day, every day, for the cost of 50g in raw mats from the AH. Hypnotic dust sells for 100g a stack, but due to the supply and demand in your market, you could sell 1 stack a day at 100g, or 10 stacks a day at 90g (again, either through undercutting or crafting). At the lower price point, I can make 400g a day everyday (at a 100g "paper" loss). Or, I could stick to the 100g price point and make 50g a day and bank 9 stacks a day for later sales and hope that those stacks will sell at 100g eventually. Only there's another 9 stacks coming in tomorrow, and another 9 the day after that, and the day after that. Or maybe I should just make the 1 stack a day, because 50g profit a day is much better than the 100g loss I was making selling 10 stacks at 90g. Right?

The defining characteristic of paper losses (or paper gains) is the unrealized part. Namely, they have not happened yet. In the real world, you can realize paper losses/gains rather easily considering IRL market prices are prices at which you have a ready buyer, by definition - if a stock price is $10 a share, that means someone (or a computer) will buy your stock at $10 right now with cash in hand. If no one would, the market price would be lower. As we all know in-game however, "market price" is really short-hand for average price for X period of time, or expected price given Y profit margin, or (as is often the case) simply wishful thinking.

It is in this context that I consider paper losses in WoW as a paper tiger, e.g. something that seems threatening but really isn't. In the example scenario posted earlier, there is really no circumstance under which "undercutting" the market price is a loss because there is no way to know what the market price even is. In the WoW economy, there is either a sale or there isn't one. Any other analysis is ispo facto navel gazing.

On Friday, as I was semi-AFK in Stormwind, someone was advertising in Trade for Heaving Plates of Protection and Kilt of Trollish Dreams "9k obo." In case you did not know, "obo" technically means "Or Best Offer," but in practice it means "I'm terrible at haggling, please gouge me." As I said in my two-part Haggling post, information is power, so why would you ever want to lead off with an admission that you would be willing to go lower? Who is going to ever offer 9k? Anyway, I whisper him with a 7,000g offer for the Heaving Plates which he accepts immediately. After paying him, I run 20 feet to the AH and list them for 21,000g.

A sale of something of that magnitude within two hours could be a fluke (the one person on the realm that would have spent that amount just happened to be browsing at that exact moment), or it could be an indication that whatever you just listed could have been listed for more. A lot more. If that was the case then, did I not experience a paper loss? And since the dude accepted my 7,000g offer instantly, does that not indicate I could have gotten it for less, perhaps 6000g? Another paper loss! And hell, what about the guy in Trade? What about his paper losses?

My first instinct is to say that my own successful sale "realized" the paper loss for the Trade guy; there was a chance to sell it for 21k (or whatever) vs guarenteed sale at 7k... at least until I guarenteed the 21k sale. But... what if the Trade guy doesn't read this blog? What if my buyer turned and sold the shoulders for 28k and I never know? What sense does a concept of paper loss make unless there is concrete, non-subjective market price?

Ultimately, I do not believe paper losses make any sense in WoW. The scenario which it attempts to describe is legitimate, e.g. being on the lookout for times when you could have sold something for more (or perhaps what will happen to Pyrite stockpiles if epic gems come from elsewhere), but in practice there is no such thing as paper losses. Return on investments? Recouping costs? Fire sales? Sure... but those only exist because the successful sale existed first.


  1. Excellent take on the market forces. Really, what more do goblins do other than ride the waves of people's concept of worth? And to that end, we make sales based on what profit margin is worth it to us.

    I prefer to keep money coming in and sales moving rather than long-term stockpiling. The value of keeping my money working is greater than the paper loss of "what could have been..."

  2. Heya Azuriel,

    Nice post.

    The fallacy, as you point out, is that the price isn't really 100g. The lowest price listed doesn't say anything concrete about the market price.

    Demand is a "curve."

    To simplify, at price = 100g, let's say there is demand for 1 stack per day. At 95g, it's 5 stacks the market wants. At 90g, demand is 50 stacks. The lower the price, the higher the demand. You could plot this as a downward sloping line on 2-dimensional graph with price on the y-axis and quantity on the x-axis.

    At any moment, the market clearing price will also depend on supply.

    In the end, you have a basic range: at the lower end of this range, you can move more product, at the higher end of the range, product will move more slowly.

    Pointing to the higher end of the market and calling that the market price (and saying that selling below that price is a paper loss) is plain wrong.

    In the stock market, volumes traded tend to be huge relative to the amounts individual investors are the little guy can pretty much sell all his stock without moving the market price.

    This isn't true in WoW, or for big market players in the market.

  3. To use a furhter Wall Street analogy, the higer priced items like your 21k Epic plays more like futures speculation. Orange futures, for example, are affected by many factors like frost on orange trees in FL or wildfires in CA.

    Similarly, the Epic armor on the AH is affected by need of raiders, what person may have been waiting to save enough to buy that piece, or whether an orb dropped for someone's crafter in a Heroic.

    This type of sale requires the seller to be invested long term--both with capital and financial stability to withstand potential losses or long sales cycles. The player with short gold stacks or less savvy may need any sale now--that 7k gold might be what he needs for a Vial of the Sands or some other 'critical' purchase for him.

    Transactional items like trade mats are much more like the S&P 500--buy when undervalued, sell when value rises--sometimes trading several times a day.

  4. Thanks for the link Azuriel.

    Today's post is also on opportunity cost.
    A Real Life Case Study in Opportunity Cost. Been getting good responses so far.

  5. I don't think this was the point of your post, but it highlights one of the reasons I never bother with putting a value on my stockpiles. I don't spend much effort calculating, or even caring about what they COULD BE worth, I only care what they ARE worth, which I won't know until I found a buyer. Someone accused me of being a lazy auctioneer because of this, but then I showed him a screenshot of all the nines at the bottom of my backpack.

    Good post!