Despite Arsenal's early dominance it was Atletico who opened the scoring in the 41st minute, as Luciano Vietto guided a pinpoint header past Bernd Leno. Jan Oblak had earlier kept the Premier League side at bay with a series of excellent saves.
The Gunners weren't behind for long, though, as 17-year-old Emile Smith Rowe levelled things up two minutes after the break with a brilliant strike.
In the shootout Henrikh Mkhitaryan, Joe Willock and Eddie Nketiah missed for the Gunners, with goalkeeper Antonio Adan netting the winning kick for the La Liga side.
Smith Rowe, Guendouzi Can Make Premier League Impacts
While the early pre-season fixtures may be without some star names, they give young players chances to make an impact, and Smith Rowe and Matteo Guendouzi caught the eye for Arsenal.
In the first period, the latter showcased strength in midfield, a composure in possession and the ability to drive forward with the ball. Arsenal columnist Tim Stillman commented on his confidence shooting from distance too:
Smith Rowe conjured the moment of the match in the second period, though, as he got the Gunners back on level terms.
The 17-year-old sauntered forward, shimmied past two Atletico defenders and dispatched a curling shot into the top corner. Charles Watts of Football.London praised the efforts of the midfielder:
While Arsenal have already made some high-profile signings, it appears new manager Unai Emery is ready to give young players a chance in his squad. Smith Rowe and Guendouzi made a fine first impression.
Arsenal's Defensive Problems Didn't Leave With Wenger
Having dominated much of the first period, Arsenal only needed to let their concentration slip for a second for Atletico to take advantage.
Angel Correa got away from Rob Holding far too easily in the buildup to Vietto's goal; the latter found himself in plenty of space in the penalty area too.
As noted by the EiF Twitter account, Correa produced a fine piece of skill to leave Holding in real trouble:
Arsenal's defence could be one of the more familiar areas of the side next season. Shkodran Mustafi and Sead Kolasnic will both be hoping to get regular game time next season, while Hector Bellerin is a key man at the back.
Based on how easily Atletico were able to get through to goal at times in this one, Emery will be aware he has a lot of work to do on the training pitch to make this side more cohesive than they were under predecessor Arsene Wenger.
Next up for the Gunners will be another high-profile friendly, as they face Paris Saint-Germain at the Singapore National Stadium on Saturday.
Atletico will also face the French champions in the ICC on Monday,