While the supporters of the soldiers declared that the charges should not have been brought in the first place, the family of Nadhem Abdullah, 18, who was beaten to death, protested against an act of "injustice".
Judge Advocate General Jeff Blackett ruled at the hearing in the military barracks at Colchester, Essex, that there was insufficient evidence to continue with the prosecution.
Mr Abdullah's family told The Independent that they were surprised and saddened by the collapse of the case. Fadil al-Saqer, a cousin, said: "We did not even know that the trial had stopped. We had members of the family and neighbours go to England because we were told that there will be justice. But this is not justice. Who can you trust?
"This is very sad. We do not know what to do now. Are they saying Nadhem was not killed?"
The trial, one of the highest profile in a series of cases arising from the Iraq war, has already cost about £10m, making it one of the most expensive court martials in recent military history.
The soldiers, all current or former members of the 3rd Battalion, the Parachute Regiment, were accused of using their "fists, boots, rifles and helmets" to kill Mr Abdullah at a roadside at al-Ferkah, in Maysan province, north of Basra, in May 2003.
The prosecution described the assault as gratuitous, unjustified and unprovoked, and the court was told that blood matching the dead man's DNA was found on a rifle used by Private Samuel May, 25.
The soldiers denied murder and violent disorder.
Judge Blackett said that he understood the problems faced in carrying out inquiries about the alleged murder because of the turmoil in Iraq. But he said: "After discarding the evidence that is too inherently weak or vague for any sensible person to rely on it, prosecution evidence is such that a reasonable jury or court martial board properly directed could never reach the high standard of proof required to be sure of the guilt of any defendant."
The judge added that the investigators made "serious omissions" in searching for hospital and burial records in Iraq and not taking DNA swabs from Mr Abdullah's relations to exclude them as a possible source of the bloodstain found on Private May's rifle. He also pointed out that the defendants were not interviewed under caution until six months after the incident.
Judge Blackett directed the panel hearing the court martial to return a not-guilty verdict on all seven defendants.
During the trial an Iraqi woman who claimed to have been brutally attacked by the paratroopers while she was pregnant admitted under cross-examination that this was a "wicked lie". She added: "I am ashamed of it [telling a lie]. I don't know what I was saying."
Last week the court was told that Samira Rishek, 18, and other witnesses were being paid $100 for giving evidence at the trial. The Ministry of Defence said that it was common practice to cover the expenses of witnesses while they gave evidence, and that in this particular case they had travelled a long distance to do so.
But Judge Blackett said yesterday: "The witnesses frequently spoke of fasil or blood money and compensation to what were patently exaggerated claims. Had the Iraqi witnesses turned out to be credible, then the case would have been stronger."
The defence solicitor Gilbert Blades said: "This [the investigation] was lamentably bad and it has been highlighted. The lessons to be learnt are that with cases like this with serious consequences they should be properly investigated. This case was not properly investigated."
Christopher Hill, representing one of the defendants, Private Morne Vosloo, said that his client had come from South Africa to join the British Army and was "proud" of it.
He said: "It is ironic that a few years ago he was playing cricket in South Africa with Kevin Pieterson. While Kevin Pieterson was winning the Ashes, my client had a murder charge hanging over him."
A spokesman for the MoD said: "The judge made clear that, on the basis of the evidence presented, very serious allegations had been made and that it was perfectly proper to take the matter to trial. Our soldiers are not above the law.
"It is right that allegations of this nature must be followed up and the evidence tested in full. This process is now complete and those soldiers still in the Army will now return to regimental duty. We are studying the judge's remarks in detail to see what lessons can be identified."
Corporal Scott Evans, 32, and Privates Bill Nerney, 24, Samuel May, 25, Morne Vosloo, 26, Daniel Harding, 25, Roberto Di-Gregorio, 24, and Scott Jackson, 26, all denied murder and violent conduct.Reuse content