Increased instability in the Middle East drove the CBOE Volatility Index, the stock market's fear gauge, more than 23 percent higher as investors scrambled for protective positions.
Wall Street retreats from its 29-month high as escalating anti-government protests in Egypt prompt investors to move away from equities.
"If you look at Egypt, the market itself is very, very small, point 07 percent of the world's stock market, but in my mind that what lies beneath scenario. So you had Tunisia, you had Yemen and in Egypt, being such a big country, it is so important as an American ally in the Middle East, I think investors are thinking that they are not quite sure what the next step is. So it makes the investors nervous," said Stephen Wood, Chief Market Strategist at Russell Investments.
In Egypt, President Hosni Mubarak sent troops and armored cars into cities in an attempt to quell street fighting and mass protests, and medical sources said at least five protesters had been killed and 870 wounded.
"If it becomes regional and if it goes from northern Africa into the oil producing states, then it becomes a critical ingredient of capitalism, oil important. So I think that's what markets are probably beginning to price out now," added Wood.
Trading volume was the highest of the year at 9.97 billion shares on the New York Stock Exchange, the American Stock Exchange and Nasdaq, compared to last year's estimated daily average of 8.47 billion shares.
The market drop ended the Dow's eight-week winning streak and pushed the S&P 500 below its 14-day moving average for the first time in two months. Disappointing results from Amazon.com and Ford further added to the gloom.
Developments in the Middle East could be a trigger for investors to sell at a time when many expected a correction after a market rally of about 18 percent since September.
Nasdaq quotations for its main stock indexes suffered an outage of nearly one hour at the open, causing confusion among traders. Nasdaq OMX Group blamed a glitch with its global index data service.
During the Nasdaq outage, traders said there were no quotes for the Nasdaq composite and the Nasdaq 100 indexes. Individual share price quotes were not affected, and trading volume was normal.
The Dow Jones industrial average ended down 166.13 points, or 1.39 percent, at 11,823.70. The Standard & Poor's 500 Index was down 23.20 points, or 1.79 percent, at 1,276.34. The Nasdaq Composite Index fell 68.39 points, or 2.48 percent, at 2,686.89.
For the week, the Dow fell 0.4 percent, the S&P lost 0.5 percent and the Nasdaq dipped 0.1 percent.
Amazon.com shares slipped 7.2 percent to $171.14 (USD), a day after the online retailer recorded revenue below the consensus view.
Ford Motor Co slumped 13.4 percent to $16.27 after a steep drop in quarterly profit. Rival automaker General Motors Co also lost 5.4 percent to $36.60.
Dow component Microsoft Corp also fell 3.9 percent to $27.75 a day after its profit dipped.
Equities garnered support earlier in the session from data showing the U.S. economy grew at a 3.2 percent rate in the fourth quarter as consumer spending accelerated. Excluding inventories sales grew about 7.1 percent, the best since 1984.