The Nikkei share average fell nearly 2 percent Wednesday after overseas shares skidded on Greece's surprise call for a referendum on a European bailout plan that investors had hoped would be the solution to the region's sovereign debt woes.
The Nikkei dropped below support at its 25-day moving average around 8,728, which has now become a resistance point.
The Nikkei cleanly sliced through support at its 25-day moving average with investors selling shares because Europe's situation is once again uncertain, said Kenichi Hirano, operating officer at Tachibana Securities.
The run-up in U.S. and Japanese shares after the European plan was decided last week was too rapid, which is why markets just as suddenly gave back those gains, he added.
Among the day's biggest losers were shares of manufacturers such as Komatsu Ltd (6301.T) that were sold off last month as fears about the European debt crisis intensified, and then gained sharply on signs of progress toward a solution.
Komatsu slipped 5.4 percent to 1,836 yen. Sony Corp (6758.T) shed 2.7 percent ahead of its earnings announcement after the close, which investors fear could reveal a downward revision to guidance after Thai floods disrupted the company's camera production.
The Nikkei <.N225? fell 1.9 percent to 8,665.20 by the midday break, after earlier declining to a three-week intraday low of 8,641.77. The broader Topix index <.TOPX> dropped 1.9 percent to 740.14.
Investors are awaiting the outcome of the U.S. Federal Reserve's policy meeting, where the central bank could prepare markets for further monetary policy easing.
Hints of further easing would weigh on the dollar and lift the yen, at a time when Japanese authorities have vowed to take action to quell the currency's strength.
Japan on Monday sold a record of nearly $100 billion worth of yen that drove the dollar from a record low around 75.31 to a high of 79.51 and investors are wary of further intervention.
Thursday is a holiday in Japan, which market participants said kept trading relatively thin on Wednesday. Morning volume was 804 million shares, still on track to top Monday's full-day total of 1.47 billion shares.
Investors are selling ahead of the holiday, locking in gains in case of further downside in U.S. stocks later, said Hideyuki Ishiguro, assistant manager of investment strategy at Okasan Securities.
Shares in Nomura Holdings (8604.T), Japan's largest investment bank, fell 3.4 percent to 284 yen after the company posted its first quarterly loss in 2- years on Tuesday, hit by a slump in Japanese stocks and sluggish trading conditions in Europe and the United States.
Nissan Motor Co (7201.T) shares slipped 3.2 percent ahead of the car maker's earnings later in the session, in line with rivals despite beating them in October U.S. auto sales. Nissan's sales rose 18 percent, as Toyota Motor Corp's (7203.T) and Honda Motor Co's (7267.T) sales fell.
Toyota's shares declined 3.1 percent and Honda's skidded 4.3 percent.
Olympus Corp (7733.T) shares edged down 0.5 percent to 1,212 yen. Japan's ruling Democratic Party will set up a panel to discuss corporate governance in response to the camera and endoscope maker's M&A scandal, a senior party official said on Wednesday.
(Additional reporting by Mari Saito; Editing by Joseph Radford)