The Aberdeen University researchers say the drug targets the build-up of a specific protein in the brain.
Alzheimer's experts were optimistic about the results, but said larger trials were now needed. Patients with mild to moderate Alzheimer's disease were given either 30, 60 or 100mg of the drug or a placebo.
The 60mg dose produced the most pronounced effect - over 50 weeks there was a seven-point difference on a scale used to measure severity of dementia. At 19 months there was no significant decline in mental function in patients taking the drug, the researchers said.
Imaging data also suggests the drug may be having its biggest effect in the parts of the brain responsible for memory.
The link between clumps or "tangles" of protein inside nerve cells in the brain and Alzheimer's disease was first made over 100 years ago.
Later shown to be made up of a protein called Tau, the tangles build up inside cells involved in memory, destroying them in the process.
Rember (methylthioninium chloride) is the first treatment specifically designed to target the Tau tangles.
Other treatments for Alzheimer's tend to focus on combating a waste protein in the brain, beta-amyloid, which is known to form hard plaques. The latest work suggests targeting Tau may produce better results.
Methylthioninium chloride is more commonly used as a blue dye in laboratory experiments.
Professor Professor Claude Wischik discovered it by accident 20 years ago, when a drop in a test tube led to the disappearance of the Tau protein he had been working on. "We have demonstrated for the first time that it may be possible to arrest the progression of this disease by targeting the tangles which are highly correlated with the disease," he said. "We did an analysis of the effect size at 24 weeks and at 50 weeks compared to the average effect size of the current treatments and it was about two and a half times better," he added.
Larger trials of the drug are planned to start in 2009, and researchers are also investigating whether the drug has a role in prevention of the disease in the first place.
Professor Clive Ballard, head of research at the Alzheimer's Society, said: "This is a major new development in the fight against dementia. It is the first realistic evidence that a new drug can improve cognition in people with Alzheimer's by targeting the protein tangles that cause brain cell death. This first modestly sized trial in humans is potentially exciting. It suggests the drug could be over twice as effective as any treatment that is currently available."
Rebecca Wood, chief executive of the Alzheimer's Research Trust, said: "In this exploratory trial, rember reduced the decline in blood flow to parts of the brain that are important for memory. "This bodes well but we need more human trials to assess the treatment's possible side effects."
She added the fact the trial was funded by a pharmaceutical company highlighted the lack of funding for Alzheimer's research in the UK.