The attack on Wednesday occurred near a patrol of US forces, police sources said.
US troops said one US soldier and many Iraqi civilians were killed by the blast, including many Iraqi children. Three US soldiers were among the wounded.
“The vehicle, laden with explosives, drove up to a Humvee before detonating. Many Iraqi civilians, mostly children, were around the Humvee at the time of the blast,” US military spokesman Sergeant David Abrams said.
Iraqi journalist Walid Khalid said a bomber wanted to detonate an explosive-laden car targeting US forces. However, the bomb detonated before it reached the US forces, he said.
One witness, Muhammad Ali Hamza, 25, said US forces turned up in al-Jedidah district to warn residents to stay indoors because of reports of a car bomb in the area.
“Children gathered round the Americans who were handing out sweets. Suddenly a suicide car bomber drove round from a side street and blew himself up,” he added.
“I was at home. I heard the explosion. I rushed outside to find my son. I only found his bicycle,” said Abu Hamed, whose 12-year-old son Muhammad was killed in the attack.
Iraqi men look at the debris after
He was speaking at Kindi hospital where hundreds of distraught parents in blood-soaked hallways were shouting and screaming. He said he had found his son in the hospital mortuary.
“I recognised him from his head. The rest of the body was completely burnt,” he said.
Hassan Muhammad, whose 13-year-old son Alaa also died, said: “Why do they attack our children? They just destroyed one US Humvee, but they killed dozens of our children.
“What sort of a resistance is this? It’s a crime.”
The last major attack involving children was a triple car bomb on 30 September against US troops inaugurating a water treatment plant in western Baghdad which killed 43 people, including 37 children who had gathered to take sweets from US soldiers.
A cameraman at the scene shortly after the bombing said the vehicle blew up in between houses, reducing parts of three houses to rubble.
Women in the street screamed in anger and sorrow near pools of blood in the street.
At the nearby Ibn Nafees hospital, several wounded were being treated, including at least one baby.
Interior Ministry sources said most of the dead and wounded were taken to another hospital.
Aljazeera reported Iraqi police sources as saying US forces have taken control of the highway in al-Rustumiya.