However, the benchmark Sensex managed to pull back and close at 14,889.25 points, down 1.17 per cent or 176.85 points, while the broadbased National Stock Exchange's S&P CNX Nifty closed at 4449.8 points, down 1.14 per cent or 51.15 points.
Indian stocks followed the bearish trend in the Asian markets on Tuesday after Asian stocks reacted to US Federal Reserve Chairman Ben Bernanke's warning on inflation on Monday, which fanned expectations of higher US interest rates later this year.
On a day when the benchmark indices breached previous lows, banking stocks fell extending their recent losses on concerns of further tightening of the monetary policy by the Reserve Bank of India to rein in inflation, which is at its highest level in nearly four years.
Canara Bank (down 7 per cent to Rs 186.3), HDFC Bank (down 4.46 per cent to Rs 1130.95) and Axis Bank (down 3.25 per cent to Rs 681.2). Realty stocks continued to move southwards with DLF (down 0.35 per cent to Rs 479.85) and Indiabulls Real Estate (down 1.82 per cent to Rs 391.15).
At the day's low of 14,645.31 points, the Sensex lost 420.79 points in mid-afternoon trade, falling below its previous low of 14,677.24 points. However, it recovered 442.72 points to touch its intraday high of 15,088.03 points.
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The total turnover on both exchanges in the cash segment was Rs 19,114 crore and Rs 54,002 crore in the derivatives segment. Brokers said retail investors were holding on to long positions since they expect a recovery in the markets.
However, if markets do not show any signs of a pullback by tomorrow, margin calls could get triggered, which could further exacerbate the situation.
Nandan Chakraborty, research head at Enam Securities, has outlined two possible scenarios for the market, depending on the way crude oil moves.
If it moves upward, Enam Securities will maintain overweight on cash, FMCG and pharma. If it does not move upward, the broking house will maintain that excess liquidity may move to India.
Sukumar Rajah, chief investment officer-equity, Franklin Templeton Investments, said, "In the near term, we are likely to witness pressure due to various factors such as policy responses to rising inflation ahead of national elections, absence of FII flows until the global scenario improves and earnings growth moderation."
Rajah further added that the India story remains intact as structural economic drivers such as positive demographics and high savings rate will drive long term economic growth.
The market breadth remained weak with 964 stocks on the advancing side and 1667 stocks on the declining side. FIIs sold equities worth Rs 910.16 crore, while domestic institutional investors bought equities worth Rs 296.39 crore, provisional figures on BSE website indicate.
The Dow Jones Industrial Average (DJIA) staged a modest comeback on Monday from Friday's nearly 400-point drop, as concerns about US consumer spending and the troubled US housing market were eased by better-than-expected sales figures from McDonald's Corporation and a surprising gain in pending home sales.