European stocks fell on Wednesday as weaker than expected economic data prompted investors to cash in recent profits, although the rising trendlines of benchmark indexes remained intact.

French carmaker PSA Peugeot Citroen
leapt 16 percent in huge volumes after the company said it was in talks over potential cooperations and alliances. Sources said the group was in advanced talks with General Motors .

The sharp rise in the shares was fuelled in part by short sellers scrambling to cut their positions, traders said. According to Data Explorers, PSA was the fourth most shorted stock on France's CAC 40 <.FCHI>, with nearly 7 percent of the company's shares out on loan, while buy-and-hold investors have been favouring rival Renault .

Data showed on Wednesday the euro zone's key service sector shrank unexpectedly in February while growth in Germany's manufacturing and services sectors also slowed when compared to the previous month. Also weighing on sentiment, the flash euro zone Purchasing Manager's Index fell more than expected to 49.4, below the 50 level that signifies contraction.

At 12:49 p.m., the FTSEurofirst 300 <.FTEU3> index of top European shares was down 0.6 percent at 1,078.34 points, further retreating from a near seven-month high hit on Monday.

The euro zone's blue chip Euro STOXX 50 <.STOXX50E> index was down 0.6 percent at 2,527.17 points.

However, technical analysts said the two-day slide in European equities looked more like a pause in a sharp rally started in mid-December, rather than a change in trend, with both the FTSEurofirst 300 and the Euro STOXX 50 remaining in their upward channels, while the DAX <.GDAXI> triggered a bullish chart signal called 'golden cross'.

BUYING VOLATILITY AS PROTECTION

Banks, among top gainers so far this year, were the biggest losers on Wednesday, with Credit Agricole down 3 percent and UniCredit down 2.4 percent.

I'm still 'long' equities, I think there's more upside potential, with the bulk of asset managers still strongly 'underweight' equities. Although at these levels, I'm starting to buy volatility as a protection, said David Thebault, head of quantitative sales trading, at Global Equities in Paris.

One thing is sure: stock pickers are back with a vengeance. Correlation between stocks has sharply dropped and it's time to go back to the fundamentals.

The two-month rally in European stocks was sparked by the European Central Bank's massive funding operation in December, when it offered three-year money at rock-bottom interest rates, drawing demand of close to 500 billion euros ($658 billion) and easing tensions in the credit market.

The ECB is set for a second long-term refinancing operation next week and economists polled by Reuters expect it to attract roughly the same volume of bids.

On Wednesday, Credit Suisse strategists raised their rating on continental European equities to benchmark from underweight to reflect the ECB's supportive monetary policy and on expectations economic conditions will improve.

While Wall Street's Dow Jones industrial average <.DJI> hit the 13,000 points for the first time since May 2008 on Tuesday, the blue-chip Euro STOXX 50 - hurt by the region's debt crisis - still needs to rally about 54 percent before reaching its own May 2008 levels.

GOLDEN CROSS

The DAX, which has already gained 16 percent in 2012, saw its 50-day moving average ticking above its 200-day average, a technical signal confirming a shift in mid-term momentum that usually means gains in the index six months down the road.

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Asset returns in 2012: http://link.reuters.com/nyw85s

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With the golden cross shaping up, the DAX is on track to reach its big target: the resistance that represents the descending line formed by peaks of 2007 and 2011, around 7,400 points. At that level, it will be time to leave this market, and go on holidays with the profits, said Franklin Pichard, director at Barclays France.

The German benchmark was ripe for a pull-back in the short term, however, with technical momentum indicators such as the relative strength index (RSI) showing the DAX in 'overbought' territory.

Around Europe on Wednesday, UK's FTSE 100 index <.FTSE> was down 0.5 percent, Germany's DAX index <.GDAXI> down 1.1 percent, and France's CAC 40 <.FCHI> down 0.6 percent.

(Reporting by Blaise Robinson; additional reporting by Francesco Canepa in London. Editing by Mark Potter)