The US had raised tariffs on Indian aluminium and steel last year and had ended India's $5.6 billion trade concessions under the Generalised System of Preferences (GSP) programme earlier this year.
Besides, the US-China trade tension also weighed on the investor sentiments. Caution was also seen ahead of the Federal Reserve meeting which will start on June 18-19.
"Domestic market has been caught in a bearish grip as investors are increasingly turning cautious led by global trade war which has got murkier. Additionally, geopolitical tensions in the Middle East triggered a sudden spurt in oil prices," said Vinod Nair, Head of Research, Geojit Financial Services Ltd.
"Domestic market consolidation will be maintained till global events unfolds like central bank and GST council meet this week. Consolidation was broad based with metals, auto, pharma and financials under performing," he added.
Metal stocks lost the most over slowdown fears. The Nifty metal index declined by 2.83 per cent.
The Sensex, after trading in the red throughout the day, closed 491.28 points or 1.25 per cent lower at 38,960.79. The Nifty also shed 148.45 points or 1.26 per cent to settled at 11,674.85.
Investor fear was also evident as the India Vix shot up by over 6 per cent.
"Local investors will be worried as to how US could react to this (India's raising tarifffs). However, FIIs will wait for any such move by the US before feeling the Indian market," Deepak Jasani of HDFC Securities told .
"$250-400 million is not a big number, but 28 items consist of almonds, walnuts and apples which affect their farmers. This could trigger a response... which will not bode well for the Indian markets," he added.
Tata Steel, Tata Motors, ONGC, Vedanta and index heavyweight Reliance Industries lost the most during the day's trade while Yes Bank and Coal India and Insosys were the only scrips who managed to finish in the green on the BSE.
( With inputs from IANS )