Reuters quoted Indian-administered Kashmir's inpector general of police as saying a car bomb was responsible.
"An army convoy carrying a brigadier was passing by but it is difficult to say whether it was hit. Six people have been killed and 25 others injured," said Tirtha Acharya, spokesman for India's Border Security Force, on Saturday.
According to the pro-independence Kashmir Media Service, the deaths occurred when Indian troops "went berserk" after the bomb blast hit a passing military vehicle killing two soldiers and wounding another.
"They opened indiscriminate fire in the fruit market killing six civilians and injuring more than 30 others. The situation in the area is reported to be tense," said the agency's website.
The separatist group Hizbul Mujahideen claimed responsibility for the attack. The organisation is one of many fighting to oust Indian security forces from the Muslim-majority area since 1989.
Two bodies lay completely dismembered on the street after the blast, which severely damaged five vehicles including one used by the army, witnesses said.
Week of bloodshed
Shopkeepers lowered their shutters and left, as the entire area was sealed by security forces. The blast disrupted traffic on a busy highway nearby.
The incident raises to 71 the number of people killed in Indian-held Kashmir since Sunday, a day after troops said they killed a top commander of the fighters, Gazi Baba, in Srinagar.
Baba was on the "most wanted" list after India accused him of masterminding an attack on its parliament in December 2001. The raid killed 15 people, including the five attackers, and led to a military standoff with Pakistan.
More than 38,000 people have died in Indian-administered Kashmir since the eruption of an anti-Indian uprising in 1989. Separatists put the toll between 80,000 and 100,000.
New Delhi and Islamabad have recently restored full diplomatic relations and cross-border bus links but India has linked fresh talks on improving ties to an end to attacks by the fighters.