The practice of holding people in one place for long periods, widely known as "kettling", cannot always be justified, a committee of MPs found.
Members of the Home Affairs Committee said it is not acceptable to impose a blanket ban on movement and peaceful protesters should be allowed to leave.
They said frontline officers must be given discretion to allow some people to escape highly-charged events.
The findings were contained in a report published by the committee into the G20 protests in the City of London.
More than 35,000 people took to the streets as world leaders met over two days at the beginning of April.
The police have endured a barrage of criticism in the aftermath of the death of newspaper seller Ian Tomlinson who was pushed to the ground during clashes.
Independent investigators have launched several inquiries after footage of officers lashing out at protesters was caught on camera.
The Home Affairs Committee report said a small number of high-profile incidents could damage the confidence of the public in police.
Members criticised senior officers for several aspects of the huge £7.2 million policing operation involving several forces.
They said that overall the operation was "remarkable successful" with little disruption to the capital but added an "element of luck" may have helped police.
MPs said images of so-called distraction tactics, shows of controlled violence against hostile individuals, shocked many and could undermine public trust.
They added "urgent action" is required to ensure officers display identification at all times. Those who do not must face the "strongest possible" disciplinary measures, they said.
Members said they were concerned untrained and inexperienced officers were left in such a "highly combustible atmosphere" at the frontline of the protests.
The committee said police should not spend money on water cannons and other equipment to create distance between them and protesters. They said the money could be better spent on training and planning.
MPs added that police organisers must also work harder to communicate with protest organisers and the media.
The report concluded: "Above all, the police must constantly remember that those who protest on Britain's streets are not criminals but citizens motivated by moral principles, exercising their democratic rights.
"The police's doctrine must remain focused on allowing this protest to happen peacefully."
Keith Vaz, who chairs the committee, said police must consider whether to continue with tactics such as 'kettling' and to ensure untrained officers are not left on the frontline.
He said: "The basic principle that the police must remember is that protesters are not criminals - the police's doctrine must remain focused on allowing protest to happen peacefully.
"In many ways this was a large protest which passed off remarkably well. But it is clear that concerns about the policing of the G20 Protests have damaged the public's confidence in the police, and that is a great shame.
"The ability of the public and the media to monitor every single action of the police through CCTV, mobile phones and video equipment should mean they take even greater care to ensure that all their actions are justifiable.
"It is unacceptable for officers not to wear identification numbers at such events, and any officers found to be deliberately removing their identification should face the strongest possible disciplinary measures."
Chief Constable South Yorkshire Meredydd Hughes, a member of the Association of Chief Police Officers (Acpo), said: "Every single public order event - from football games and festivals through to large scale protests, provides the service with fresh opportunities to learn and improve the way that we do things.
"Policing must be proportionate, lawful, accountable and necessary, and we accept that we will not get it right every time.
"What's important is that we take those opportunities, encourage debate and as a service, respond appropriately to criticism.
"The G20 was one of the largest security operations ever mounted in this country and we are pleased the committee recognises its overall success.
"Every weekend, many protests happen across the UK with little or no involvement from the police service - largely due to good communication between protesters and the police.
"What is clear is that there are concerns that we need to address as a service and we will study this report carefully alongside the other reviews and inquiries under way."
Paul McKeever, chair of the Police Federation of England and Wales, said officers need a wide range of tactics to deal with riots, demonstrations and public order situations.
He said: "We are the lawfully appointed authority designated to accommodate lawful protests but this must continue to be done whilst balancing the rights and needs of the majority to conduct their daily lives as uninterrupted as possible.
"Containment as a tactic allows for the protection of property, the minimising of disorder, the identification of offenders and the ability of others to go about their lawful business.
"We accept however that the employment of this tactic may occasionally result in the detainment of some people not involved in the protest, but what has to be considered is the alternative.
"By choosing a method such as dispersal and allowing groups of demonstrators to roam around areas at will you are allowing, at best, disruption to the lives of non-protesters and at worst serious disorder.
"We support the contention that containment must be proportionate to the circumstances and intelligence gathered. We also believe its use must always be balanced against the need to take measures against the potential for much greater disorder."
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