Analysts said sentiment in the Japanese market remained positive, underpinned by encouraging US jobs data and expectations of aggressive monetary stimulus under new Prime Minister Shinzo Abe, which have weakened the yen and boosted exporters' shares over the past two months.

 But they also noted that a correction was no surprise with technical charts signalling overbought levels.

By the midday break, the Nikkei dropped 0.2 percent to 10,666.20, after rising as high as 10,743.69 in early trade.

"Investors have been carefully waiting for the timing to take profits as they believed the market can't keep rising," said Yutaka Miura, a senior technical analyst at Mizuho Securities.

"If volume keeps up, the drop may not be sharp," he added.

The broader Topix was flat at 888.63 in active trade, with 1.87 billion shares changing hands. It compares with 3.53 billion shares, average trading volume in the final week of December.

The Nikkei has risen about 23 percent since mid-November when Abe started calling for aggressive easing, taking the Nikkei deeper into "overbought" territory.

On Monday, foreign brokers placed net buy orders of 11.3 million shares, their largest net purchase since Dec. 17.

Its 14-day relative strength index is at 81.94, far above 70 which is considered overbought and often indicates an imminent adjustment.

The Nikkei is trading 8.7 percent above its 25-day moving average of 9,816.24.

"There is strong caution against the steep rises in the market in a short period of time," said Kenichi Hirano, a strategist at Tachibana Securities.

Some exporters succumbed to profit-taking, with Canon Inc dropping 1.2 percent and Toshiba Corp shedding 1.1 percent.

But others were still in demand, with Honda Motor Co gaining 0.9 percent and Nissan Motor Co rising 1.2 percent.

"Japanese shares will likely continue attracting buying as the conditions are good for them," said Hiroichi Nishi, general manager at SMBC Nikko Securities, adding that some investors believe exporters' earnings will be better than expected.

On Friday, the dollar climbed to a nearly 2-1/2 year peak against the yen after senior Federal Reserve officials raised concerns about the risks of its stimulative monetary policy.

The dollar rose as high as 88.40 yen, according to Reuters data, the highest since July 2010. A weaker yen lifts exporters' overseas earnings when repatriated.

But utility stocks tumbled, becoming the second-worst sectoral performer after Nomura Securities cut its ratings on some power utility companies. Kansai Electric Power Co tumbled 3.9 percent after Nomura cut its rating to "reduce" from "neutral", saying changes were unlikely in the Nuclear Regulation Authority's stance against reopening nuclear plants unless they are deemed safe.

Kyushu Electric Power Co fell 2.7 percent after Nomura cut its rating to "reduce" from "neutral".

Center>Copyright Reuters, 2013