Founded by Peter Stephens in the 1730s, the colonial town was chartered and named for Lewis Stephens in October 1758. It was originally settled by German Protestants from Heidelberg. Stephens City is the second-oldest municipality in the Shenandoah Valley after nearby Winchester, which is about to the north. "Crossroads", the first free black community in the Valley in the pre-Civil War years, was founded east of town in the 1850s. Crossroads remained until the beginning of the Civil War when the freed blacks either escaped or were recaptured. Stephens City was saved from intentional burning in 1864 by Union Major Joseph K. Stearns. The town has gone through several name changes in its history, starting as Stephensburg, then Newtown, and finally winding up as Stephens City, though it nearly became Pantops. Interstate 81 and U.S. Route 11 pass close to and through the town, respectively.
A large section of the center of the town, including buildings and homes, covering , is part of the Newtown-Stephensburg Historic District and was listed on the National Register of Historic Places in 1992. Stephens City celebrated its 250th anniversary on October 12, 2008. The town is a part of the Winchester, Virginia-West Virginia Metropolitan Statistical Area, an offshoot of the Washington–Baltimore–Northern Virginia, DC–MD–VA–WV Combined Statistical Area. It is a member of the Winchester–Frederick County Metropolitan Planning Organization.