At 10.05 a.m., the Sensex traded 129 points or 0.7 per cent higher at 18,593 while the Nifty gained 43 points to 5,621. Markets had opened gap up after witnessing the biggest one-day gain of 2012 last week.
Heavy selling was seen in defensive counters such as healthcare and FMCG because of the rise in risk appetite. The BSE IT index slipped 2.2 per cent, the most among all groups of stocks.
HCL Tech was the top Nifty loser, down 3 per cent followed by tobacco major ITC and IT major TCS. Both these stocks traded 2.5-3 per cent lower.
However, aviation and retail stocks gained the most after the government announced its decision to open up the retail and airlines sector to foreign investment.
Kingfisher Airlines was locked up, rising 20 per cent at Rs 12.97, while SpiceJet soared 13.5 per cent. Retail stocks also saw strong buying. Pantaloon Retail traded with 18 per cent gains.
The reform measures came on the back of hike in subsidised diesel prices on Thursday, which would ease concerns over rising subsidy bill. The measure was aimed to rein in a ballooning fiscal deficit and avoid a credit rating downgrade to junk.
Rate sensitive stocks - banks, auto and realty - traded with strong gains ahead of the Reserve Bank's mid-quarter policy review. The central bank is expected to hold rates for a fifth straight month because of sticky inflation. However, markets have risen to a 14-month high expecting a rate cut and a disappointment may lead to a correction in prices.
Private sector lender Axis Bank surged over 4 per cent while ICICI Bank and country's largest bank SBI traded 3.5-4 per cent higher. A rate cut may lead to rise in demand for credit off take for lenders.
"The only negative is that on two occasions markets have gapped up. It is difficult to initiate fresh trades in such a market. I would advise investors to hold on to their long rates with a stop loss of 5,444 and not book profits," independent analyst Sarvendra Srivastava said.
Global cues continue to be supportive. Asian stocks touched their highest in more than four months on Monday and gold, oil and copper hovered near multi-month highs, after rallying late last week on hopes that fresh stimulus from the world's top central banks will support flagging growth.
The tone has been bullish in financial markets since the European Central Bank said on September 6 it would intervene in the bond markets to drive down the borrowing costs of struggling euro zone members. A second monetary shot-in-the-arm was delivered by the Fed, which said it would pump $40 billion into the economy each month until the jobs market shows sustained improvement, powering U.S. stocks to their highest close in nearly five years on Friday.
(With inputs from Reuters)