One man had died in the road accident earlier on the Srinagar-Jammu highway passing through the district. Local residents converged on the streets soon after and traffic on the national highway was also affected.
The police said security forces opened fire after the protest turned violent and people started throwing stones at the security forces.
"We are getting details how it happened," said Swayam Prakash Pani, Deputy Inspector General of Police south Kashmir.
He, however, underlined that the police had arrested the BSF driver involved in the road accident but the people did not disperse.
There was already tension in the area because a terrorist killed in an operation in Anantnag district's Kokernag area also belonged to Khudwani.
A joint team of the military's Rashtriya Rifles, the Central Reserve Police Force and the Jammu and Kashmir Police had killed a Hizbul Mujahedeen terrorist earlier in the day, identified as Mohd Furhan Wani. Reports said he was 18-year-old and had recently joined the terror group.