It's the same reason as to why the 'defense line' of Israel around the Gaza border was breached, neither the government/army nor their people were expecting Palestinians to do ground operations. They are only used to rockets being fired.
As far as the settlers being armed; being armed doesn't necessary mean that you're capable of defending yourself. Remember, the only reason they had the upper-hand was because only Israelis were allowed to be armed whereas Palestinians were prohibited, as stipulated by Israeli laws, even if they lived in the same neighborhood. And once they meet their true match, they have to square off on the same level without getting external support.
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