About 3,000 protesters marched from Atocha railway station to the central Plaza de la Provincia behind a banner declaring "Sahara Free now!", an AFP photographer said.
Banners from many parts of Spain could be seen at the demonstration which also included live music and street performers dressed in the red, green, black and white of the traditional Saharawi flag.
"We believe the Sahawari people have to right to self-determination," said Jose Taboada, president of the Coordination of Spanish Associations of Solidarity with Western Sahara, which organised the protest and wants the territory to vote on independence.
Western Sahara, larger than Britain but with a population of just 260,000, has lucrative phosphate reserves, rich fishing grounds and potentially oil.
Morocco took control of most of the territory in November 1975 when colonial power Spain withdrew, prompting a guerrilla war for independence that lasted until 1991 when the United Nations brokered a ceasefire and sent in a peacekeeping mission.
Many thousands of its people live in refugee camps across the border in Algeria.
Morocco wants talks about self-rule for the territory under Moroccan sovereignty, but the territory's Algerian-backed Polisario independence movement has demanded a referendum that would include the option of full independence.
The protest was staged to coincide with a European conference for support for the Saharawi people held in Madrid.
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