The jumper, which she wore at a polo match in 1981 while engaged to the future King Charles III, sold for £920,000 ($1.14 million) after 15 minutes of bidding.
It is the most expensive jumper ever sold at auction. The sweater was originally estimated to be sold for somewhere between $50,000 and $80,000.
The knit piece was created by the label Warm & Wonderful, and features rows of white sheep contrasted with a solitary black sheep in the front.
The label was requested by Buckingham Palace to secure a replacement after Diana's original jumper was damaged.
She wore the replacement jumper at a 1983 polo match.
Diana's sweater was part of Sotheby's Fashion Icons auction, which also included a dress worn by former US first lady Michelle Obama, as well as garments worn by actresses Kate Winslett and Sarah Jessica Parker.