A youth, who had his face masked, waved the flag of the terror group during the rally organised by Ummati Islami to commemorate the death anniversary of separatist leader Qazi Nisar Ahmad.
This is the second week in succession that Islamic State flag has been waved during a rally.
Last week, IS flag was waved during a protest rally at Jamia Masjid in Nowhatta area of the city.
Hardline Hurriyat Conference leader Syed Ali Shah Geelani had asked the youths to desist from waving IS flags during protest rallies as it gives Government of India an opportunity to "defame the indigenous struggle" of Kashmiris for right to self-determination.
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