After rising nearly 180 points in early trade on firming trend overseas on Federal Reserve's upbeat outlook on the US economy, the Sensex fell back to end 44.45 points, or 0.18 per cent, at 25,201.80.
Intra-day, it swung in a 350-point range when it touched a high of 25,425.85 but fell to a week's low of 25,069.55.
The 30-share Sensex had lost 274.94 points in the previous session on rising crude import costs and weak rupee.
Brokers said the market remained volatile as investors and foreign funds were adopting a cautious approach, amid concerns that rising global crude prices will fuel inflation and raise import bill and hurt country's economy growth.
A higher opening of the European market, helped select stocks to recover from day's low levels, they added.
Oil prices rose in afternoon Asian trade after Iraq's government appealed for the US to carry out air strikes on jihadists who on Wednesday seized another oil refinery.
The US benchmark West Texas Intermediate (WTI) for July rose 44 cents to USD 106.41 while Brent crude for August gained 18 cents to USD 114.44 in afternoon trade.
The broad-based NSE 50-issue Nifty, after rising to 7,606.45 at the outset, succumbed to selling pressure and ended 17.50 points or 0.23 per cent, lower at 7,540.70.
"Domestic bourses were seen reacting positively to the dovish statement made by the Fed. But as the day progressed, negativity on global front due to Iraq turmoil dragged our markets down," said Jayant Manglik, President-retail distribution, Religare Securities.
Stocks of ONGC, India's largest state-owned oil explorer, plunged 5.13 per cent, the most in three years, GAIL lost 1.88 per cent, while RIL fell 2.38 per cent, the most in a month.
Shares of state-run oil companies, HPCL plunged 3.97 per cent and BPCL lost 4.67 per cent.
Other laggards include Maruti Suzuki India which dropped by 2.48 and Hero MotoCorp by 0.52 per cent.
However, gains in srips such as Infosys, ITC, HDFC Dr Reddy's, Sun Pharma and Bajaj Auto trimmed Sensex's losses.
Meanwhile, Foreign Portfolio Investors (FPIs) bought shares worth a net Rs 366.18 crore yesterday.
Anindya Banerjee, currency analyst, Kotak Securities: Indian Rupee gained today on the back of dovish policy outlook from the US Fed. US fed has once again downgraded its economic outlook for the US economy, which is a hint that interest rate hikes are going to be delayed further. As a result, US Dollar weaknes against major currencies in the Asian markets and that has spilled over into strength for the local unit. Rupee is now trading around 60.00 against the US Dollar. It remains hostage to the geopolitical tensions in Middle East. Over the near-term, the pair is expected to remain volatile within a broad range of 59.75/80 and 60.40/50 levels on spot. In case, the geopolitical tensions are defused, we can see Rupee trade at levels of 59.30/50 levels on spot.
Debopam Chaudhuri, Chief Economist, ZyFin Research: The outcome of the US FED meeting was on expected lines, with monthly bond purchases to be reduced by another USD10 Billion. The US Economy is expected to grow between 2.1-2.3% in 2014. Impact of withdrawal of the Fedss QE programme has greatly diminished, partly because Indian markets have factored this in and partly due to strengthening in Indias external sector over the past few months. In fact, a growing US economy is expected to lend support to Indian exports, thereby reducing the trade deficit.