The Nifty rose to a two-year high on Wednesday, breaching the key psychological level of 6,000 at one point, after a U.S. deal on its so-called "fiscal cliff" sparked broad buying, while financial firms extended a recent rally on hopes of a rate cut this month.
U.S. lawmakers approved a plan to prevent huge tax increases and delay spending cuts that together would have pushed the world's largest economy into a likely recession.
However, despite expectations sturdier global economic growth and the Reserve Bank of India's easing actions would support portfolio inflows, some fund managers warned Indian shares are looking overbought in the near-term after rallying in 2012.
"Ahead of earnings season there would be profit booking in January as corporates may stick to giving cautious outlook," said Deven Choksey, MD, K R Choksey Securities.
Reversal of interest rate cycle which can spur growth and thereby markets, however, remain key for the medium term, added Choksey.
The benchmark BSE index rose 0.68 percent, or 133.43 points, to end at 19714.24, after earlier rising to its highest close since January 6, 2011.
The broader NSE index rose 0.71 percent, or 42.40 points, to end at 5993.25.
The index earlier rose to as high as high as 6,006.05 points, marking its highest intraday level since January 7, 2011.
Shares have rallied since last year, with the BSE Sensex up 1.5 percent in the two trading sessions so far this year after surging 25.7 percent in 2012.
Also aiding the sentiment, India's manufacturing activity surged to a six-month high in December, boosted by strong factory output and a spike in new orders, both of which hit their highest levels since June, a business survey showed on Wednesday.
Financial shares led the gainers on growing hopes the RBI will cut interest rates for the first time since April when it meets on January 29.
Housing Development and Finance Corp rose 1.6 percent, while ICICI Bank ended 1.3 percent higher.
Bajaj Auto rose 3.3 percent, marking its all-time high close, after reporting 13 percent growth in total sales in December 20.
Shares of Bharat Heavy Electricals Ltd rose 2.3 percent after the government imposed a 35 percent safeguard duty on electrical insulators imported from China, in a bid to protect domestic manufacturers from cheaper shipments.
Aurobindo Pharma rose 4.3 percent, extending Tuesday's 2.14 percent gain, after it said it has got final approvals from U.S. FDA for Rizatriptan Benzoate tablets and the product is ready for launch.
However, among decliners, consumer stocks such as ITC fell as traders tracked a global 'risk-on' mood.
ITC fell 0.64 percent, while Hindustan Unilever ended 0.02 percent lower.
Bombay Stock Exchange's fast-moving consumer goods index rose 46.6 percent last year, marking it one of the best-performing sectors.