Protesters fled the scene on hearing the shots but quickly regrouped chanting "We are going in."
Minutes later, protesters began chanting "Silmiya, Silimya" (Peaceful, peaceful) as several of them sat down on a nearby bridge blocking traffic.
The protest -- which would have been banned under the regime of ousted president Hosni Mubarak -- was timed to coincide with establishment of Israel 63 years ago, commonly referred to in Arabic as the "Nakba" or "catastrophe."
The Israeli embassy, on the top floor of a residential building overlooking the Nile, was protected by army and police officers who barricaded the narrow street leading to the entrance.
But protesters had massed on surrounding streets and the nearby bridge.
Pointing to the flag raised above the embassy, they chanted "Bring it down, Burn it!".
At one point, army and police officers were showered with flyers thrown from the bridge which read: "Stemming from our belief in the Palestinian cause, and the desire to free the Palestinian people, a segment of Egyptian youth has decided to take responsibilty for reviving this cause."
The flyers said there would be awareness campaigns on the Palestinian cause, and aid would be organised for the Palestinian people.
Protesters also called for the end of gas deals with Israel, the release of all Palestinian detainees and an end to the Gaza blockade.
Meanwhile, Egyptian authorities had blocked access to the Sinai peninsula to prevent a march from Cairo to Gaza, an AFP correspondent in Sinai said.
The march was due to leave from Cairo's Tahrir Square on Saturday to protest the Israeli occupation of Palestinian land, and call for the right of return of Palestinian refugees and the release of all Palestinian prisoners.
"Peace Bridge", one of the main access routes to Sinai from mainland Egypt, has been closed to all but residents of the peninsula.
The army also stepped up security around the peninsula, a security official said.