* Nikkei falls to 1-½ week low as yen extends gains in Asia
* Long-term bullish trend stays, Japanese shares still cheap
* Nikkei slips slightly below 25-day moving average
By Chikafumi Hodo
TOKYO, Dec 30 (Reuters) - Japan's Nikkei average dropped 1.2 percent to a 1-½ week low on the final trading day of the year on Thursday, pressured by profit-taking as the yen advanced to a fresh seven-week high against the dollar.
Japanese shares came under broad selling pressure as investors lightened their buy positions ahead of the New Year holidays as the yen's strengthening took market participants by surprise.
"The recent advance of the yen has been a bit unexpected and clearly having a negative psychological impact on share prices," said Takashi Ohba, a senior strategist at Okasan Securities.
The benchmark Nikkei ended morning trade at a session low of 10,215.81, down 128.73 points from the previous close. The Nikkei was at its lowest since Dec. 20.
The broader Topix index fell 1.1 percent to 898.11.
Volume picked up from the previous day, with 732 million shares changing hands on the Tokyo Stock Exchange's first section by midday, from 559 million on Wednesday. It was slightly above last week's average midsession turnover of 725 million shares.
The dollar was down 0.3 percent at 81.38 yen in Asian trade. It fell as low as a fresh seven-week low of 81.28 yen earlier.
The technical trend also deteriorated after the Nikkei fell slightly below the closely watched 25-day moving average, now at 10,220, and market players were watching whether it could recover beyond the level by the close.
Analysts said a short-term technical indicator also signalled that the Nikkei could be still overbought.
The "toraku," or up-down ratio, was at 131 as of Wednesday, still above the 120 level that signals an overheated market. The ratio is calculated by dividing the 25-day moving average of stocks that gained by the 25-day average of those that fell.
Still, the long-term outlook for Japanese shares stayed bullish as investors were eager to buy on views that they remain undervalued compared with those in other developed markets. The Nikkei has gained nearly 10 percent in the last quarter of 2010, but is still down about 3 percent for the year.
"The long-term bullish trend in Japanese stocks is still in place, but we have to remember that this scenario is only alive as long as the yen won't rise too rapidly," said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
Shares of exporters fell, reflecting the stronger yen. Sony Corp dropped 1.4 percent to 2,914 yen and Panasonic lost 1 percent to 1,153 yen.
But Hitachi rose 0.5 percent to 427 yen following a series of reports about the country's biggest electronics conglomerate.
Mitsubishi Heavy Industries Ltd and Hitachi will jointly bid for a 350 billion yen ($4.3 billion) rail project in Bangkok, pushing the two Japanese conglomerates closer to merging their overseas rail businesses, the Yomiuri newspaper reported on Thursday.
Mitsubishi Heavy fell 1.3 percent to 305 yen.
On Wednesday, the Sankei newspaper reported the company is likely to clinch a contract for a UK rail network project as early as the start of next year.
Agility Trains, a consortium consisting of Hitachi and British infrastructure project manager John Laing, have been the preferred bidders on the contract. ($1=81.61 Yen) (Reporting by Chikafumi Hodo; Editing by Chris Gallagher)