Falls tracked lower global shares after a paper from the San Francisco Federal Reserve Bank released on Monday argued that investors could be underestimating the speed at which the US central bank might raise interest rates.
Foreign investors have been a key driver of this year's record-setting rally in Indian shares, and as of Tuesday had been net buyers for a seventh consecutive session, bringing their total for the year to USD 13.94 billion.
Caution is also expected to prevail ahead of the consumer inflation data due on Friday, the last one before the Reserve Bank of India's policy review on Sept. 30.
"Today's fall is more of a technical correction, which will give a better entry for fresh participants. A larger amount of capital investment is awaited. We are relatively more positive towards the market," said Deven Choksey, managing director, KR Choksey Securities.
The benchmark BSE index closed down 0.76 percent at 27,057.41, retreating further from a record high of 27,354.99 hit on Monday.
The broader NSE index fell 0.72 percent to 8,094.10, moving away from its record high of 8,180.20 hit on Monday.
Blue-chips, which have traditionally attracted the bulk of foreign investments, led falls. Reliance Industries Ltd  fell 1.7 percent, adding to its 0.5 percent drop on Tuesday, while Infosys Ltd closed down 1.8 percent.
ITC Ltd fell 2 percent after the Economic Times newspaper reported the government was considering tougher regulations on tobacco, including banning the sale of loose cigarettes. An ITC spokesman was not immediately reachable for comments.
State-run oil marketing companies ended lower on profit-taking. Bharat Petroleum Corp Ltd fell 2.3 percent, while Indian Oil Corp closed 1.7 percent lower.
Among other stocks, infrastructure companies declined for the second day. Larsen & Toubro closed 1.3 percent lower, adding to its 1.5 percent fall on Tuesday, while Bharat Heavy Electricals Ltd closed down 0.95 percent.
Among gainers, ICICI Bank Ltd rose 1.6 percent after the bank's board on Tuesday approved a five-to-one stock split that traders said should increase liquidity.

Shares in Wockhardt Ltd closed 0.7 percent higher on plans of merging two units with the company, which analysts said would help increase overall revenues.

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