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Watson studied at the University of British Columbia and later at the University of Toronto under Marshall McLuhan, where her thesis focused on the work of English painter and author Wyndham Lewis. Between 1933 and 1952 she worked as an elementary and high school teacher in New Westminster, Dog Creek, Mission City, Duncan, and Powell River, British Columbia. She also taught at Moulton Ladies College in Toronto between 1946 and 1949. Between 1949 and 1951 she was a sessional lecturer at the University of British Columbia. In 1961, Watson was hired as a professor of English at the University of Alberta. She retired in 1975.

She is best known for her modernist novel The Double Hook (1959), which was a seminal work in the development of contemporary Canadian literature. She also published a novel Deep Hollow Creek, which she had written in the 1930s, in 1992. It was shortlisted for the Governor General's Award. Watson was also a founding member of the short-lived arts journal White Pelican.

Watson was awarded the Royal Society of Canada's Lorne Pierce Medal in 1984.

A biography, Always Someone to Kill the Doves: A Life of Sheila Watson by F.T. Flahiff was published in 2005.

The archives of Sheila Watson are currently preserved at the University of St. Michael's College at the University of Toronto.

The third epigraph of Canadian novelist Margaret Atwood's The Blind Assassin reads

The word is a flame burning in a dark glass. ... Sheila Watson

According to Nathalie Cooke,this is from Deep Hollow Creek, and it announces Atwood's third dominant theme, the power of the word itself.

Sheila Watson is mentioned in about 1,800 books.

Novels

• The Double Hook — 1959
• Deep Hollow Creek — 1992

Short Stories

• Four Stories — 1979
• Four Stories — 1984
• A Father's Kingdom — 2004