The 53-year-old, who played 178 times for the Hatters during two spells at Kenilworth Road, scoring 32 goals, had previously been in charge of Oxford City, leading them to fourth in the National League South.
Oldfield, who was sold by Luton to Manchester City for £600,000 in March 1989, re-signing for £150,000 six years later, takes over from Brian Stock, who was sacked after seven straight defeats which left the Terras 21st in the table.
Weymouth chairman Ian White told the club's official website: "I'm really pleased that David has joined us.
"I am really looking forward to working with him and together I am certain that we can turn the club’s fortunes around on the pitch.
"His pedigree speaks for itself and I know he will be up for the challenge.”
Meanwhile, Justin Merritt, director of football at Oxford City, said: “David goes with our thanks and we wish him well for the future.
"He leaves the team in great shape and the club remains fully focused on our continued progression.
"There is now a fantastic opportunity for someone to come in and continue to take us forward.”
Oldfield takes over with Weymouth four points from safety after 14 defeats in 21 matches this season, as he prepares for a trip to Boreham Wood on Saturday.