The exchange of fire between the two sides ended late last night but the security forces did not lift the cordon with the aim of stopping the militants from fleeing.
Floodlights were installed around the encounter site to ensure that militants don't escape the security dragnet.
Witnesses said that forces fired in air to disperse protesters who had gathered in Heff village.
At least 10 paramilitary Central Reserve Police Force troopers were injured as clashes erupted on Saturday between protesters and Indian armed forces near Kashmir's Shupian district, police said. A top police official said two militants are holed up in the house which was cordoned off by the army and police's Special Operations Group following a tip-off.
Shopian is one of most militancy-infested areas of south Kashmir. The militants have been reported to escape.
According to reports, militants threw a grenade and opened fire on forces triggering an encounter.As the security forces were closing in, they came under fire from the militants, he said.