Robin Hood vs. Goliath

At the start of this year, one story has stolen the market's attention: the rise and fall of GameStop (GME). The video-game retailer has been in the focus of small investors, of the sophisticated hedge funds and, recently, of the U.S. financial-market regulator.

From what we've seen in recent weeks, it's useful to explain a few concepts.

First, the risks of short selling. When you sell short, there is no limit to the potential loss, because a stock's value has no ceiling. Someone who borrows a share at $5 and later has to buy it back at $20 must pay four times what they invested. This is what enormously hurt the hedge funds, even though they are Wall Street giants.

Second, brokerage apps like Robin Hood halted trading in some stocks because regulation requires it, not because there is a conspiracy behind it. Custody houses require collateral to move the shares while awaiting the cash flow. How much capital they require is a function of volatility and other factors. The brokerages ran out of capital to cover those requirements.

Finally, it's tempting to think that this dynamic of small investors coordinated through social media could affect markets more broadly, David vs. Goliath. While we can't rule out that this will happen again, even on a larger scale, the probability of a significant effect at the aggregate market level is very low. The available evidence shows some correlation in small-cap stocks but no effects are observed in large companies.

What happened with GME will inspire more than one book and perhaps a movie, but it's important to look beyond the narrative to draw lessons when investing.