After a difficult 1936 season in which Mercedes withdrew midway through the year, the company established a new racing department, the Rennabteilung, and appointed Rudolf Uhlenhaut to lead the design of a successor to the W25. Uhlenhaut, previously a production car engineer, had no prior experience designing a racing car but brought deep knowledge of vehicle dynamics from testing road cars at the Nürburgring. His testing of the W25 revealed that the suspension was too stiff, causing the chassis to flex and the rear axle to bend by up to 7–10 cm under braking. The W125's brief therefore called for a stiffer chassis paired with greater suspension travel.
The W125 was built around a tubular frame of oval nickel-chrome molybdenum steel tubes, significantly stiffer than the W25 structure. The bodywork was bare aluminium, left unpainted — a practice shared with rival Auto Union that gave both teams' cars the enduring nickname Silver Arrows, as German racing colours were officially white but the paint was stripped to save weight.
The engine, designated M125, was a supercharged double overhead camshaft 5,663 cc inline-eight with a bore and stroke of 94 mm × 102 mm. Using a Roots-type supercharger and a custom fuel blend of 40% methyl alcohol, 32% benzene, 24% ethyl alcohol, and 4% gasoline, power output ranged from 560 to 595 hp at 5,800 rpm in race trim. On the test bed the highest recorded figure was 637 bhp. The engine weighed 222 kg, roughly 30% of the car's total mass. A 4-speed constant-mesh gearbox replaced the sliding-mesh unit of the W25, improving reliability.
A separate Rekordwagen variant fitted with a V12 engine was built for land speed record runs, reaching 432.7 km/h over a measured mile and kilometre in 1937.
The W125 debuted at the 1937 Tripoli Grand Prix in May, where Hermann Lang took victory on the car's first outing. At the AVUS circuit in Berlin, Mercedes ran a streamlined variant alongside a standard car; the streamliner retired with a gearbox failure, but the circuit's long straights had demonstrated the car's top speed of well over 300 km/h.
In the 1937 European Championship, Mercedes dominated. Caracciola won the German Grand Prix at the Nürburgring and the Italian Grand Prix at Livorno, with Manfred von Brauchitsch winning at Monaco. Caracciola's victory at Livorno, by 0.4 seconds over Lang, sealed the European Championship, and Mercedes drivers occupied the top four positions in the final standings — Caracciola ahead of von Brauchitsch, Kautz, and Lang.
A key mid-season development was the adoption of a suction carburettor supercharger system, first tested on Christian Kautz's car at the Eifelrennen. After Richard Seaman used the system to finish second at the Vanderbilt Cup in the United States, the updated configuration was fitted to all W125s for the remainder of the season. The car's final competitive win came at the Masaryk Grand Prix in Czechoslovakia, where Caracciola, von Brauchitsch, and Seaman took the top three places. The season's final race, the Donington Grand Prix, went to Auto Union's Bernd Rosemeyer.
One race was overshadowed by tragedy: at the Masaryk Grand Prix, Lang crashed into spectators on lap five, causing twelve injuries and two deaths.
The W125 remained widely regarded as the most powerful road racing car ever built for approximately three decades, until the large-displacement American V8 engines of CanAm sports cars reached comparable outputs in the late 1960s. In Formula One, the power figure was not surpassed until turbocharged engines appeared in the early 1980s. The car was retired at the end of 1937 when rule changes imposed a 3,000 cc limit on supercharged engines for 1938; Mercedes responded by developing the W154 rather than modifying the existing car.