As candidates were told about the outcome behind closed doors, the UKIP leader tweeted: "As a veteran of over thirty by-elections, I have never seen such a perverse result. Serious questions need to be asked."
Mr Farage later claimed he had evidence from an "impeccable source" that postal voting was "bent".
According to Sky's Political Editor Faisal Islam, UKIP supporters were "angry and annoyed" as the votes were counted.
Labour's Jim McMahon saw off the party's challenge with a majority of more than 10,000 and an increased share of the vote.
John Bickley collected 2,405 fewer votes than UKIP's candidate back in May - although the turnout was considerably higher at the General Election.
He claimed the postal voting system was "not fit for democracy right now", while UKIP's deputy leader Paul Nuttall said postal votes had "distorted the result".
Mr Nuttall said: "We should go back to the old system where you had to give a good reason why you can't get off your backside and go down to a polling booth.
"That would make it fair again. That would make polling day actually mean something."
Mr McMahon, the leader of Oldham Council, dismissed Mr Farage's accusations of irregularity.
""There is nothing wrong with people making a democratic decision not to support UKIP," he said.
Labour leader Jeremy Corbyn said the result was a "vote of confidence in our party".
"Jim McMahon will make an excellent MP and a worthy successor to Michael Meacher, and I am looking forward to welcoming him to Labour's team at Westminster," he said.
"Jim ran a great campaign, focusing on bringing jobs to Oldham and giving every child the best opportunities.
"By-elections can be difficult for the party holding the seat, and turnouts are often low. But to increase our share of the vote since the general election is a vote of confidence in our party."
Mr McMahon polled 17,209 votes, with Mr Bickley trailing him in second on 6,487, a majority of 10,722.
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