We analyze the causal impact of high frequency trading on market quality, retail traders’ trading costs and profits. On April 1st, 2012 the Investment Industry Regulatory Organization of Canada started charging its members an initially unknown cost recovery fee per exchange message (e.g., orders, trades, cancellations) that had the potential to be very costly for high message traffic participants, predominantly high frequency traders (HFTs). Following the introduction of the fee, high HFT reduced their market activity significantly, both in absolute terms and as a percentage of overall market activity. Using the fee change as an exogenous instrument, we employ trader-level data to estimate the causal effect of HFT activities on market quality and on the costs and profits of other traders, in particular of retail traders. The retraction of HFTs from the market causes a decrease in market liquidity and in the trading profits (increased losses) of retail traders, particularly in high volume stocks. Our works suggests that, contrary to the commonly held opinion, HFTs appear to not impose negative externalities on the least sophisticated market participants and that they may be beneficial to slower and less sophisticated traders.

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