The area around Gabrovo, inhabited since the Neolithic, gained economic importance after Veliko Tarnovo became capital of the Second Bulgarian Empire in the 12th century. Craftsmanship and trade prospered due to the proximity to both the capital and the Balkan passes. Medieval Gabrovo was a small pass village of about 100 houses.

According to the most widespread legend, Gabrovo was founded by a young blacksmith called Racho, close to whose fireplace a hornbeam (габър, gabar in Bulgarian) rose, so the settlement acquired its name.

After the Ottoman invasion of the Balkans in the 14th century, the demographic position of Gabrovo changed significantly, as it was the only settlement in a considerably large geographic area and an attractive place for Bulgarians fleeing from the conquered capital and neighbouring fortresses. It turned from a village into a small town (palanka) and began to develop as an economic, cultural and spiritual centre.

During Ottoman rule, the rich tradesmen spent plenty of resources for the small town's public planning. The first Bulgarian secular school, the Aprilov Gymnasium, was founded in Gabrovo in 1835 with the aid of Vasil Aprilov and Nikolay Palauzov. Gabrovo was officially proclaimed a town by the Ottoman authority in May 1860.

Shortly before and after the Liberation of Bulgaria in 1878, Gabrovo developed as a centre of industry on the basis of its economic traditions. Joint-stock companies emerged, factories were constructed and connections to the large stock exchanges were created, prompting some to label the town "The Bulgarian Manchester".