The S&P BSE Sensex fell 150 points on Tuesday as traders booked profits ahead of the two-day meeting of US central bank on 16 and 17 September.
The Sensex ended 0.58% at 25,705 points, while the 50-share Nifty fell 43 points, or 0.55%, to close at 7,829 points.
"Just when we thought that the rising intermediate trend is here to stay, markets once again witnessed some selling pressure. Traders and investors preferred to stay on the sidelines or book some profits ahead of the Fed Meet, which is scheduled to be held this Wednesday and Thursday. Drop in cash volumes; dip in delivery volumes and no real signs of any short covering so far have kept the traders on tenterhooks," said Amar Ambani, Head of Research, IIFL.
Investors booked profits in bank stocks which had gained in the previous session on expectations of an interest rate cut by the Reserve Bank of India (RBI) as early as this month.
The sell-off was also partly due to resumption of weakness in the Chinese equity markets. China's Shanghai Composite index plunged 3.5% to end at 3,005 points.
Indian markets ended lower going into the US Federal Reserve meeting on Wednesday and Thursday; there is 50% probability of a rate hike announcement at the meeting.
"The most recent FOMC survey shows 55% looking for no change and 45% looking for a hike, but that probably understates the shift in opinion, as those looking for 'no change' are more convinced of their case than those expecting a hike," said Societe General in a note.
Among the sectoral indices, metal and capital goods were the biggest losers, dropping by over 2%. Tata Steel, Vedanta, Tata Motors, Hindalco, L&T and Axis Bank were ended in the red.
Aviation stocks rose sharply after budget carrier IndiGo received the market regulator's nod for its Rs 2500-crore initial public offer (IPO), Business Standard reported.
While Jet Airways ended 1.8% higher, Spicejet shares went up by 5.6%.
Shares of FMCG companies also ended in the green after a data showed that inflation fell to 3.66% in August.
Gold prices also traded weak, as investors remained cautious in taking bets. The yellow metal ended Rs10 lower at Rs 26,350 per 10 gm. Silver prices slumped by Rs 300 to Rs 34,500 per kg amid a weak demand by industrial units and coin makers.
The rupee also ended lower at 66.37 against the US dollar, as the demand for the greenback went up amid weakness in domestic equities.