Wales' Selby, 25, was a big favourite for gold but came up against an inspired local fighter and some controversial officiating.
"I don't know what went wrong for me, I can't explain. I thought I'd win comfortably," Selby said.
"I came here for a gold for myself and Wales."
Selby's elimination comes as a further blow for Wales after team-mate Fred Evans was denied accreditation to fight at the Games.
Motherwell's McFadden, 19, took the fight to Selby and clearly won the first round, catching his opponent with rugged shots from either hand.
Selby hauled himself back level in the second but continually lost his gumshield in the decider, prompting Turkish referee Yasar Cinar to twice deduct points.
The deductions effectively ended the contest and, as Selby grew increasingly frustrated, McFadden celebrated his win in front of a cheering crowd.
"I can't make excuses. You could see I was rushing, getting caught and it was obviously not my day. It just caught me by surprise," Barry's Selby added.
"I knew the crowd would be cheering for him but I didn't expect him to be showboating.
"It just all took me by surprise. Everything went wrong. I can't say why because I don't know. I'm in the best shape of my life and I've been at training camps. "
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