Several Pakistani flags were waved at Shah's rally in Anantnag town, 52 kms from here, soon after Friday prayers, police sources said.
The green flags of the neighbouring country were also waved from atop the vehicle where Shah was addressing the crowd, they said.
A some among the crowd also set ablaze BJP flags during the rally.
Soon after the rally, Shah was taken into custody by police from Khanabal when he was on his way back home in Srinagar, the sources said.
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This is fourth incident of waving of Pakistani flags in Kashmir since April 15 this year when the green flags appeared at a rally held to welcome hardline Hurriyat Conference chairman Syed Ali Shah Geelani upon his arrival from New Delhi.
Influential separatist leader Masarat Alam Bhat was arrested in connection with that incident.
Pakistani flags also appeared at Geelani's rally at Tral two weeks later and then at Jamia Masjid here on May 20.
Meanwhile, BJP spokesman Khalid Jehangir said the act of hoisting Pakistani flags would not be tolerated and action as per law should be taken against the culprits.