The encounter started after army and police launched a joint operation after receiving a tip-off about the presence of some terrorists in Naidkai village.
As the security forces zeroed in the cordon they came under heavy fire. In the ensuing encounter one soldier was killed.and two terrorists hiding inside a house in the area were shot dead.
Firing exchanges have stopped in the area, but a combing operation is on.
Two AK 47 rifles and other arms and ammunition were recovered from the site of encounter.
The security forces have also launched another anti-terror operation in the adjacent Sopore area of north Kashmir.