Another eight Palestinians were wounded when around 40 Israeli army jeeps and armoured trucks stormed Ram Allah on Tuesday evening.
The troops entered the city shortly after 1630 GMT, imposed a curfew in the town centre and surrounded the Abdul Nasser mosque, according to witnesses.
Palestinian sources also said around 10 Israeli jeeps invaded the nearby university town of Bir Zeit, close to where a group of Israeli soldiers was ambushed on Sunday night.
Three of the soldiers were shot dead in the attack claimed by the Al-Aqsa Martyrs' Brigade, an offshoot of Yasir Arafat's Fatah movement.
An Israeli military source confirmed that forces had entered Ram Allah in an operation against its "terrorist infrastructure".
Ram Allah is home to Palestinian leader Yasir Arafat, who has been confined to his heaquarters by the Israelis for almost two years.
Arafat called on the international community on Tuesday to halt Israel's "military folly," while thousands of mourners buried the victims of a series of air strikes in the Gaza Strip.
"I appeal to the international community, the United Nations and the quartet to stop this military folly through which they (the Israelis) are looking to destroy our holy ground and our people," Arafat said.
The Israelis claim the Ram Allah
raid is to hunt down 'terrorists'
He was making his first response to five separate air strikes on the Gaza Strip on Monday which claimed the lives of 10 people and wounded 70 others.
The latest violence came after Israeli Prime Minister Ariel Sharon repeated threats to remove Arafat from the Occupied Territories.
Following the threats, Palestinian leaders sprang to Arafat's defence.
Usama Hamdan, Hamas' representative in Beirut, said: "We support the chairman of the Palestinian Authority and his rejection of being removed from the Palestinian territories
"We reaffirm that any move by the occupation forces to remove Arafat will face a violent response from the Palestinian people and the Palestinian resistance."
And Ahmad Abd al-Rahman, an Arafat aide, said: "I tell Sharon that hurting Yasir Arafat or the Palestinian Authority will mean that the Palestinian people shall recant their recognition of the state of Israel and its security.
"The Israelis should know that the Palestinian people have given a great deal for a peaceful settlement, but will never give away Palestinian territories to settlers, nor to the Israeli occupation forces."