Holliday began her show Business career in 1938, under her original name, as part of a nightclub act called The Revuers. The other members of the group were Betty Comden, Adolph Green, Alvin Hammer, John Frank and Esther Cohen. The Revuers played engagements in New York night clubs including the Village Vanguard, Spivy's Roof, Blue Angel, Rainbow Room, and Trocadero in Hollywood, California. Leonard Bernstein, a friend of the group who shared an apartment with Green at the time, sometimes provided piano accompaniment for the group's performances. The Revuers filmed a scene for the 1944 Carmen Miranda film Greenwich Village, but the scene was cut, although Holliday can be seen as an unbilled extra in another scene. The group disbanded in early 1944.

Her first film role was a small, but noticeable role as an airman's wife in the Twentieth Century Fox film version of the U.S. Army Air Forces' play Winged Victory (1944). She did not appear in the stage version, which toured the U.S. both before and after production of the film. Holliday made her Broadway debut on March 20, 1945 at the Belasco Theatre in Kiss Them for Me and was one of the recipients that year of the Clarence Derwent Award.

In 1946, she returned to Broadway as the scatterbrained Billie Dawn in Born Yesterday. Author Garson Kanin wrote the play for Jean Arthur, who played the role of Billie out-of-town but left the role for personal reasons. Kanin then selected Holliday, two decades Arthur's junior, as her replacement. In his book Tracy and Hepburn (1971), Kanin mentions that when Columbia bought the rights to the film Born Yesterday, studio boss Harry Cohn would not consider casting the Hollywood-unknown. Kanin, along with George Cukor, Spencer Tracy, and Katharine Hepburn conspired to promote Holliday by offering her a key part in the film Adam's Rib (1949).

In 1948 Holliday married clarinetist David Oppenheim, who was later a classical music and television Producer and academic. The couple had one child, Jonathan, before they divorced in 1958. She then had a long-term relationship with jazz musician Gerry Mulligan, but she never married him. Musically talented herself, Holliday supplied lyrics to Mulligan for the theme song he composed for the 1965 film A Thousand Clowns.

In 1950, Holliday was the subject of an FBI investigation looking into allegations she was a Communist. The investigation "did not reveal positive evidence of any membership in the Communist Party" and was concluded after three months, unlike many others tainted by the Communist investigation. In 1952, she was called to testify before the Senate Internal Security Subcommittee to "explain" why her name had been linked to Communist front organizations. She was advised to play dumb (like some of her film characters), which she did very well.

Holliday was born Judith Tuvim (Hebrew: tovim means good, Yiddish: yomtoyvim means holidays, literally "good days") in New York City. She was the only child of Helen (née Gollomb) Tuvim and Abe Tuvim, who later served as the executive Director of the foundation for the Jewish National Fund of America (1951-1958). Her mother, who was previously divorced, taught piano for many years and was of Russian Jewish descent like her Father. Growing up in Sunnyside, Queens, New York, Judy graduated from Julia Richman High School there. Her first job was as an assistant switchboard operator at the Mercury Theatre, which was administered by Orson Welles and John Houseman.

In 1952, Holliday was called to testify before the Senate Internal Security Subcommittee to answer claims she was associated with communism.

She starred opposite then-newcomer Jack Lemmon in his first two feature films, the popular comedies It Should Happen to You and Phffft! (both 1954)

In November 1956, Holliday returned to Broadway starring in the musical Bells Are Ringing with book and lyrics by her Revuers friends, Betty Comden and Adolph Green, and directed by Jerome Robbins. In 1957, she won the Tony Award for Best Leading Actress in a Musical. Of her performance in the stage musical Brooks Atkinson wrote in The New York Times;

She had throat surgery shortly after leaving the production in October 1960.

Her last role was in the stage musical Hot Spot, co-starring newcomers such as Joseph Campanella and Mary Louise Wilson, which closed after 43 performances on May 25, 1963.

A long-time, “heavy smoker”, Holliday died from breast cancer on June 7, 1965, just two weeks before her 44th birthday. She was interred in the Westchester Hills Cemetery in Hastings-on-Hudson, New York. Five years prior to her death, she was awarded a star on the Hollywood Walk of Fame at 6901 Hollywood Boulevard in Los Angeles.

She received rave reviews for her performance in Born Yesterday on Broadway, and Cohn offered her the chance to repeat her role for the film version, but only after she did a screen test (which at first was used only as a "benchmark against which to evaluate" other actresses being considered for the role). She won the first Golden Globe Award for Best Actress – Motion Picture Musical or Comedy and at the 23rd Academy Awards, Holliday won the Academy Award for Best Actress, defeating Gloria Swanson, nominated for Sunset Boulevard, Eleanor Parker, for Caged, and Bette Davis and Anne Baxter, both for All About Eve.