Dietrich was born Marie Magdalene Dietrich on 27 December 1901 in Schöneberg, a district of Berlin, Germany. She was the younger of two daughters (her sister Elisabeth being a year older) of Louis Erich Otto Dietrich and Wilhelmina Elisabeth Josephine Dietrich (née Felsing).

Dietrich's mother was from a well-to-do Berlin family who owned a clockmaking firm and her father was a police lieutenant who had served in the Franco-Prussian War. Her father died in 1907. His best friend, Eduard von Losch, a first lieutenant in the Grenadiers courted Wilhelmina and eventually married her in 1916, but he died soon after as a result of injuries sustained during World War I.

Von Losch never officially adopted the Dietrich children, hence Dietrich's surname was never von Losch, as is sometimes claimed. She was nicknamed "Lene" (pronounced Lay-nay) within the family. Around the age of 11, she contracted her two first names to form the then-unusual name, Marlene.

Dietrich attended the Auguste Victoria School for Girls from 1906 to 1918. She studied the violin and became interested in the theatre and poetry as a teenager. Her dreams of becoming a concert violinist were cut short when she injured her wrist.

In 1921, Dietrich auditioned unsuccessfully for theatrical director and impressario Max Reinhardt's drama academy; however, she soon found herself working in his theatres as a chorus girl and playing small roles in dramas, without attracting any special attention at first.

Dietrich made her film debut playing a bit part in the 1922 film, So sind die Männer. She met her future husband, Rudolf Sieber, on the set of another film made that year, Tragödie der Liebe. In the G. W. Pabst film, Die freudlose Gasse (1925), the actress playing Elsa is Hertha von Walther (1903-1987), who looks very much like the young Marlene Dietrich, giving rise to the false rumor that Dietrich has a bit part in this film.

Dietrich and Sieber were married on 17 May 1924. Her only child, daughter Maria Elisabeth Sieber, later billed as actress Maria Riva, was born on 13 December 1924.

Dietrich continued to work on stage and in film both in Berlin and Vienna throughout the 1920s. On stage, she had roles of varying importance in Frank Wedekind's Pandora's Box, William Shakespeare's The Taming of the Shrew and A Midsummer Night's Dream as well as George Bernard Shaw's Back to Methuselah and Misalliance. It was in musicals and revues, such as Broadway, Es Liegt in der Luft and Zwei Krawatten, however, that she attracted the most attention.

By the late 1920s, Dietrich was also playing sizable parts on screen - the most notable films being Café Electric (1927), Ich küsse Ihre Hand, Madame (1928) and Das Schiff der verlorenen Menschen (1929).