The Dow Jones industrial average closed down almost 115 points after giving up an early gain of 93. The Dow and broader indexes lost more than 1 percent.
The euro gave stocks a boost early in the day when European Union countries sent bailout money to Greece. The move raised confidence about Europe's ability to prevent its debt crisis from spreading to other economies including the U.S.
By afternoon, though, the upbeat mood faded and the euro fell. That sapped the stock market's strength. Treasury prices rose after demand for safer investments increased.
The euro, the currency shared by 16 European nations, has been driving stock trading for weeks as investors interpreted its slide as a sign of continuing economic problems in Europe. It hit a new four-year low of $1.2160 on Tuesday.
Meanwhile, Germany said it is banning "naked" short selling, which occurs when traders bet on a stock or investment that they doesn't own. The ban covers government debt certificates and shares of several financial companies. The government said it was imposing the rule in hopes of keeping the financial markets stable.
Investors anxious about Europe's problems were further rattled by Germany's move. Naked short selling was cited as one of the factors in world markets' turbulence during the 2008 financial crisis. The latest step brought reminders of the desperation that U.S. regulators signaled in trying to stabilize the market and underscored a fear that a further drop in the euro will continue to pound world markets.
"If Europe really slows, the threat would be that it could take down the rest of the global economy," said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland. He noted, however, that most economic numbers don't suggest that a recovery is stalling.
McCain said long-term investors should gather more evidence before making big changes to their portfolios.
"The markets tend to move in excesses of optimism and pessimism," he said.
The Dow fell 114.88, or 1.1 percent, to 10,510.95. It has fallen three of the past four days.
The Standard & Poor's 500 index fell 16.14, or 1.4 percent, to 1,120.80, while the Nasdaq composite index fell 36.97, or 1.6 percent, to 2,317.26.
Major stock indexes are down about 8 percent from their 2010 highs in late April. That puts the market close to the threshold for a correction, which is usually defined as a drop of 10 percent to 20 percent.
Bond prices jumped, driving yields lower. The yield on the benchmark 10-year Treasury note fell to 3.35 percent from 3.50 percent late Monday.
Stock trading has been volatile for weeks. The Dow rebounded from a drop of 184 points to end Monday with a gain of about 6 points after the euro strengthened.
Mike Shea, managing partner at Direct Access Partners LLC in New York, said that with so many unanswered questions about the ballooning debts in Europe it isn't surprising to see traders selling.
"There is a prudent reduction of risk," Shea said.
The concerns about the ban on naked short-selling hit large banks, a sign that traders are uneasy about the possible chilling effect that Germany's moves might have on the markets and in turn, financial companies. Traders are also watching the financial overhaul bill making its way through the Senate. Debate could end as soon as Wednesday. Some traders are concerned that tighter rules will hurt bank profits.
Wells Fargo & Co. fell $1.38, or 4.3 percent, to $30.59, while Citigroup Inc. fell 13 cents, or 3.4 percent, to $3.73.
Gold fell $13.50 to $1,214.60 an ounce, while crude oil fell 54 cents to settle at $69.41 per barrel on the New York Mercantile Exchange.
While so much attention has focused on Europe in recent weeks, investors have largely ignored signs of economic growth. Stocks had been posting solid gains earlier in the year on steady signs of improvement in the U.S. economy. Encouraging signals on the economy gave early support to stocks Tuesday. The Commerce Department said home construction jumped 5.8 percent in April, more than expected and the strongest level since late in 2008.
John Merrill, chief investment officer at Tanglewood Wealth Management in Houston, said investors are doing some mental juggling. They see signs that the U.S. economy is strengthening but still have concerns that Europe's problems will undermine the global economy's rebound.
"There are just two alternative themes and it just depends on where the focus is," he said.
Wal-Mart Stores Inc. was the sole stock among the 30 that make up the Dow Jones industrials to rise. The world's largest retailer posted better-than-expected earnings. Investors also look to companies that sell consumer staples as a safe investment in weak economies. The stock rose 98 cents, or 1.9 percent, to $53.71.
More than three stocks fell for every one that rose on the New York Stock Exchange, where consolidated volume came to 6.2 billion shares, compared with 5.9 billion Monday
The Russell 2000 index of smaller companies fell 12.96, or 1.9 percent, to 682.75.
Britain's FTSE 100 index rose 0.9 percent, Germany's DAX index gained 1.5 percent, and France's CAC-40 rose 2.1 percent. Japan's Nikkei stock average rose 0.1 percent.
Credits: AP Associate Press
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