The osmolyte trimethylamine N-oxide (TMAO) accumulates in the cell in response to osmotic stress and increases the thermodynamic stability of folded proteins. To understand the mechanism of TMAO induced stabilization of folded protein states, we systematically investigated the action of TMAO on several model dipeptides (leucine, L(2), serine, S(2), glutamine, Q(2), lysine, K(2), and glycine, G(2)) in order to elucidate the effect of residue-specific TMAO interactions on small fragments of solvent-exposed conformations of the denatured states of proteins. We find that TMAO preferentially hydrogen bonds with the exposed dipeptide backbone but generally not with nonpolar or polar side chains. However, interactions with the positively charged Lys are substantially greater than with the backbone. The dipeptide G(2) is a useful model of the pure amide backbone; interacts with TMAO by forming a hydrogen bond between the amide nitrogen and the oxygen in TMAO. In contrast, TMAO is depleted from the protein backbone in the hexapeptide G(6), which shows that the length of the polypeptide chain is relevant in aqueous TMAO solutions. These simulations lead to the hypothesis that TMAO-induced stabilization of proteins and peptides is a consequence of depletion of the solute from the protein surface provided intramolecular interactions are more favorable than those between TMAO and the backbone. To test our hypothesis, we performed additional simulations of the action of TMAO on an intrinsically disordered Aβ(16-22) (KLVFFAE) monomer. In the absence of TMAO, Aβ(16-22) is a disordered random coil. However, in aqueous TMAO solution, Aβ(16-22) monomer samples compact conformations. A transition from random coil to α-helical secondary structure is observed at high TMAO concentrations. The coil to α-helix transition is highly cooperative especially considering the small number of residues in Aβ(16-22). Our work highlights the potential similarities between the action of TMAO on long polypeptide chains and entropic stabilization of proteins in a crowded environment due to excluded volume interactions. In this sense, the chemical chaperone TMAO is a nanocrowding particle.