By Tanya Agrawal and Yashaswini Swamynathan
(Reuters) - U.S. stocks fell sharply on Friday, with the Dow Jones industrial average dropping as much as 538 points, as Britain's vote to quit the European Union sent a shock wave through global financial markets.
The S&P 500 index and Dow were on track for their biggest one-day percentage drop since September, while the Nasdaq composite index was headed for its worst day since August. All three indexes were set for their second weekly decline in a row.
Global financial markets plunged and sterling sank to its lowest since 1985 after Britons voted by about 52-48 percent to break away from the world's biggest trading bloc.
"A lot of investors and market participants were not anticipating this outcome," said David Lefkowitz, senior equity strategist at U.S. Bank Wealth Management Americas in New York.
At 13:47 a.m. ET the Dow (DJI) was down 509.31 points, or 2.83 percent, at 17,501.76, the S&P (SPX) was down 63.32 points, or 3 percent, at 2,050 and the Nasdaq Composite (IXIC) was down 180.39 points, or 3.67 percent, at 4,729.65.
If the Nasdaq closes down by more than 179.79 points, it would be its biggest one-day points drop since September 2008, at the start of the financial crisis.
Investors worried about the outlook for the world economy sought refuge in the dollar and other traditional safe-harbor assets such as gold and U.S. Treasury bonds, while dumping riskier shares. The yield on the U.S. 10-year T-bond hit its lowest since 2012.
Banks stocks, which had risen strongly this week in anticipation that Britain would stay in the EU, were among the biggest losers.
The financial index (SPSY) fell 4.74 percent, leading sector decliners, and was set for its worst day in 10 months.
Citigroup (N:C) was down 8.4 percent and Morgan Stanley (N:MS) 9.6 percent, while Bank of America (N:BAC), JPMorgan (N:JPM) and Goldman Sachs (N:GS) dropped by between 6 and 7 percent. U.S. banks have big London operations.
Nine of the 10 major S&P 500 sectors were lower. Only the utilities sector (SPLRCU) managed to eke out a gain. Utilities are traditionally seen as a safe investment.
Shares of the biggest U.S. tobacco companies also rose, as investors sought stocks offering high yields. Altria Group (N:MO), the largest U.S. cigarette maker, was up 2.3 percent at $67.85 after hitting a record high of $67.97.
The CBOE VIX (VIX) volatility index - known as Wall Street's fear gauge - was up 35.3 percent at 23.34 in afternoon trading. The index had earlier surged as much as 52.11 percent to 26.24, its highest since February.
The market was already expected to be volatile on Friday as traders adjust portfolios to account for an annual reconstitution of the widely followed Russell stock indexes.
About 6.94 billion shares had changed hands on U.S. exchanges by 01:36 p.m. ET, according to Thomson Reuters data. By that time, volume was roughly 1.6 times the normal pace of the last 22 sessions, according to Trade Alert data.
"We're going to have to wait out 36 or 72 hours before making a final judgment on what the outcome of the referendum means for the market," said Art Hogan, chief market strategist at Wunderlich Securities in New York.
The number of S&P futures contracts traded by 9 a.m. ET had already exceeded their daily average for the past year. Trading in S&P 500 and Nasdaq futures was halted briefly overnight after they fell more than 5 percent, triggering limit thresholds.
Britain's FTSE 100 stock index closed down 3.2 percent after dropping as much as 8.7 percent. Asian stocks also tumbled.
U.S. short-term interest rate futures rose amid speculation the Federal Reserve could cut interest rates to help shield the economy from any global fallout.
Investors have been waiting for the Fed to raise borrowing costs as the economy improves.
The Federal Reserve, which had earlier said a Brexit could have "significant repercussions" on the economic outlook, sought to calm markets on Friday by saying it was ready to provide dollar liquidity.
Oil prices, which are sensitive to changes in the economic outlook, dropped about 4.4 percent, the biggest fall since early February. [O/R] Exxon (N:XOM) and Chevron (N:CVX) were down about 1.7 percent.
Among gold miners, Barrick (N:ABX) was up 5.7 percent and Newmont Mining (N:NEM) was up 5.1 percent.
Apple (O:AAPL), which got more than a fifth of its revenue from Europe last quarter, was down 2.5 percent.
Declining issues outnumbered advancing ones on the NYSE by 2,575 to 480. On the Nasdaq, 2,465 issues fell and 393 advanced.
The S&P 500 index showed 27 new 52-week highs and nine new lows, while the Nasdaq recorded 23 new highs and 96 new lows.