NEW YORK (Reuters) - Cisco's discouraging outlook dragged Wall Street lower yesterday, but the market fought back in a sign the bullish trend remains intact.

Cisco lost 16.2 percent to $20.52 after its earnings report. Major indexes plunged shortly after the open, with Nasdaq falling more than two percent, but slowly came back as investors viewed Cisco's problems as company-specific.

"This is a recipe for disaster but the fact is, the market is doing pretty well," said Stephen Massocca, managing director at Wedbush Morgan in San Francisco.

"The market is exhibiting considerable strength here, considering the run we've had in the past few weeks, negative news out of Cisco, and the dollar doing well."

In the past, major averages have taken a bigger beating the day after Cisco's earnings disappoint.

Short-term technical indicators suggest the stock market is still in an uptrend, and options action in Cisco reversed earlier bearishness as traders moved to rebuild bullish positions.

"There was a panic sell-off initially (on Cisco's outlook) but people are starting to realise that maybe this is just a Cisco-specific story," Massocca said.

Cisco stock suffered its worst one-day percentage drop since July 14, 1994, when it slid 17.71 percent, according to Thomson Reuters Datastream. However, Cisco's decline accounted for more than half of the losses in the Nasdaq 100 Index.

The Dow Jones industrial average fell 73.94 points, or 0.65 percent, to 11,283.10. The Standard & Poor's 500 Index shed 5.17 points, or 0.42 percent, to 1,213.54. The Nasdaq Composite Index lost 23.26 points, or 0.90 percent, to 2,555.52.

Cisco's warning dragged down shares of other tech heavyweights. Microsoft Corp lost one percent to $26.68, and Hewlett-Packard Co dropped 2.5 percent to $43.06.

More than 531 million shares had traded in Cisco, the fourth busiest day in the stock's history, according to Thomson Reuters Datastream.

Cisco's disappointing outlook came as the market's recent rally lost steam. Tech shares have led that rally, with the S&P information tech index up about 21 percent from the end of August, compared with the S&P 500's gain of about 16 percent.

The day's decline has helped the market recover from an overbought condition, with the smoothed relative strength index (RSI) at about 63, off a recent high of 78.

Cisco's and the broader tech sector's sell-off pointed to the need for diversification, said Kevin Mahn, chief investment officer at Hennion & Walsh Asset Management in Parsippany, New Jersey, which has about $300 million in assets under management.

"Investors should look to build more diversification in their portfolios, relying not just on normal bellwethers like tech," Mahn said. "I'd recommend people look to places like small-caps, emerging markets and different kinds of bonds."

In the options market, many investors took positions betting on the recovery in Cisco's shares.

"It seems a number of options traders see the new value of the shares as attractive and ripe for harvest," said Caitlin Duffy, options strategist at Interactive Brokers Group.

More than 1.03 million option contracts have changed hands on Cisco Systems, with investors favouring calls over puts in afternoon trade.

Trading volume was about 7.8 billion shares on the New York Stock Exchange, the American Stock Exchange and Nasdaq, compared with the year-to-date daily average of 8.72 billion.

In spite of the major stock indexes ending yesterday's session with gains, the market's breadth was decidedly negative.

About 19 stocks fell for every 10 that rose on the New York Stock Exchange, while on the Nasdaq, about 17 stocks fell for every nine that rose.