Ellenberger took advantage of Shields closing the gap for a takedown attempt, wrapping his hands around Shields' neck, sinking a knee into his stomach and then dropping him with a knee to the head.
Shields crumpled face down and Ellenberger pounded away with a half dozen lefts to the head until referee Kevin Mulhall stepped in to stop the fight.
"I wish we got to fight a little more but it is what it is," said the 32-year-old Shields, a former Strikeforce title-holder. "It's the ref's decision, I wanted to keep fighting. He did hit me good, I'm not taking anything from Ellenberger but I thought I had a little fight left. The ref thought it was time to stop it, so nothing I can do."
The televised "UFC Fight Night" card was held at the Ernest N. Morial Convention Center.
Shields (26-6-1) was coming off a loss to champion Georges St-Pierre at UFC 129 in April in Toronto, a defeat that ended a win streak that stretched 15 fights and more than six years.
He decided to go ahead with the Ellenberger bout despite the death of his 67-year-old father Jack, who doubled as his manager, on Aug. 29.
The 26-year-old Ellenberger (26-5) has won his last five in the UFC since losing his Octagon debut to Carlos Condit in 2009.
"Unbelievable." said Ellenberger. "Jake Shields is a world champion, I mean I can't explain how I feel right now. It feels great."
Ellenberger had wanted to keep the fight standing while Shields, a jiu-jitsu black belt, had wanted to get it to the ground.
Middleweight Alan (The Talent) Belcher, returning from an 16-month absence after two sets of surgery to fix a detached retina, celebrated his comeback at the expense of Canadian Jason (The Athlete) MacDonald.
Belcher (16-5) used a vicious ground-and-pound attack to stop the 36-year-old from Red Deer, Alta., by verbal tapout at 3:48 of the first round.
"I'm back, baby," said Belcher, a 27-year-old native of Arkansas who now makes his home in near Biloxi, Miss.
MacDonald (26-15) tried to get Belcher to the canvas down from the start but ended on his back when he tried to drag Belcher down from the fence. Belcher hurt him from inside the guard and then pounded away with elbows and fists.
A battered MacDonald tried to fight back with a kimura attempt, but Belcher simply beat him down.
MacDonald made a comeback of his own at UFC 129, when he returned from a gruesome leg injury to submit Ryan Jensen.
The veteran middleweight had two steel plates and 10 screws inserted in his left ankle in a loss at UFC 113 in Montreal in May 2010. Fighting John Salter, MacDonald's leg got caught as he was being taken down. He broke both the tibia and fibula and tore both ligaments off the bone.
Featherweight Erik (New Breed) Koch won a 30-27, 29-28, 30-27 decision over Jonathan Brookins, lightweight winner of Season 12 of "The Ultimate Fighter."
Koch (13-1) used striking and kicks to score the win over Brookins (13-4), who was making his debut at 145 pounds.
Middleweight Court (The Crusher) McGee, winner of TUF Season 11, outlasted South Korean Dongi (The Ox) Yang to win a 30-27, 29-28, 30-28 decision.
McGee (12-1) was coming off a broken hand and knee injury.
The action heated up in the third round when Yang (10-1) felled McGee with a left, only to have his face bloodied as he tried to finish McGee off. The South Korean seemed to visibly tire as the round wore on and McGee took him down twice in the final minute.
The South Korean survived a guillotine attempt as the final bell went.