The BSE Sensex fell more than 2 percent on Monday, with the Nifty retreating from a near 2-1/2 year high and ITC slumping from a record high, as investors viewed a recent four-week rally as excessive after data showed a jump in the trade deficit.
A 138 percent jump in gold imports last month lead to a surge in India's trade deficit, raising concerns about the current account deficit and offsetting any comfort policymakers took from slowing inflation.
Weaker Asian shares also weighed on sentiment after China posted surprisingly feeble factory output growth, while fixed-asset investment slowed.
Shares have gained 7.8 percent since mid-April, spurred by a rally in the global markets, as easier monetary policies among major central banks raised the prospects of increased foreign inflows.
Analysts said they expected stocks to remain supported by that global liquidity, although economic indicators - including wholesale price due on Tuesday - and political developments ahead of elections expected by next year would also be key.
"Purely on account of international liquidity, we have seen massive inflows and markets have been rallying for the past few weeks," said Kaushik Dani, fund manager Peerless Mutual Fund.
"For me it is more of a correction that was due for quite some time since the rally was quite ahead of fundamentals," added Dani.
2.14 percent, or 430.65 points, to end at 19,691.67, marking its biggest daily percentage fall since May 2012, and retreating after ending on Saturday at its highest close since January 6, 2012.
The broader Nifty fell 2.08 percent, or 126.80 points, to end at 5,980.45, retreating from its highest close since January 2011.
Foreign institutional investors have been net buyers for 15 consecutive sessions, bringing their total investment for the year to $12.70 billion, regulatory data shows.
Until Monday, those purchases had helped send Indian shares higher.
"Nifty may fall to 5,900 on profit-taking, but it's a buy-on-decline market given the liquidity in the global context," said Deven Choksey, managing director at KR Choksey Securities.
Dealers cited caution ahead of the cigarette maker's January-March earnings due on Friday as well as speculation ITC's weighting may be reduced by index compiler MSCI, which is expected to announce its semi-annual review this week.
ITC shares had gained 7.7 percent in May, as of Saturday's close.
Technology stocks such as Tata Consultancy Services Ltd
TCS fell 2.6 percent, while Infosys Ltd
ICICI Bank Ltd
All three banks declined comment.
Essar Oil Ltd
Among stocks that gained, Jubilant Foodworks Ltd
(Additional reporting by Himank Sharma; Editing by Anupama Dwivedi)