The story opens in the town of Springwood, Ohio as a yellow school bus delivers students home after school. Soon, there are only two teenaged girls and a nerdy guy in the back of the vehicle.
Suddenly the bus driver accelerates the bus, passes a regular stop and hurtles into a desert landscape, with lightning striking and a darkening sky. The driver transforms into fire-scarred Freddy Krueger (Robert Englund), with a bladed right-hand glove with razor-sharp talons and his trademark fedora hat and red/green striped sweater, who has commandeered the bus.
When the bus comes to a halt, the ground opens and the bus teeters precariously on the top of two narrow spires or pinnacles within a huge fissure. As Freddy makes his way toward the terrorized teenagers, the weight of the bus shifts dangerously, and he uses his gloved hand to rip large gashes in the seat cushions.
He raises his taloned hand, ready to strike. The scene shifts away from the nightmare. The next scene is in the kitchen of the Walsh household, where a tomato is being sliced on a cutting board. At the breakfast table is the all-American Walsh family: husband Ken Walsh (Clu Gulager), wife Cheryl Walsh (Hope Lange), precocious 11 year-old daughter Angela (Christie Clark), and upstairs, teenaged son Jesse (Mark Patton).
Upstairs, Jesse is heard screaming and waking up from the school-bus "bad dream" - he is recognizable as the nerdy boy on the bus. Almost every morning, Jesse wakes up covered in sweat after another nightmare. The family had moved into the house only a few weeks earlier, and Jesse still hasn't fully unpacked.
During an intramural softball game in gym class, Jesse gets in a scuffle with athletic student Ron Grady (Robert Rusler), who had yanked Jesse's gym pants down resulting in a ground wrestle between the two.Coach Schneider (Marshall Bell) disciplines both of them. The two are forced to do multiple push-ups side-by-side, when Grady mentions that the Coach is known to hang around queer S & M joints downtown - "He likes pretty boys like you."
In the shower room after their punishment, Jesse explains how he had moved into the Thompson home. The house at 1428 Elm Street was recognizable with bars on the window. Grady reveals some past history about one of its occupants: tormented teen Nancy Thompson had survived Freddy Krueger's dream terrorization, but ultimately went crazy.
That night, Jesse has trouble sleeping (although he experiences the following nightmare): Jesse goes downstairs to the kitchen, when he notices a figure outdoors peering at him through the window from behind bushes. He ventures outside to his cellar window, where he sees Freddy (with his hat and red/green striped sweater) inside his own basement, bent down and reaching for something inside the firebox of a furnace lit with a burning fire.
In a sweat, Jesse returns to the house and goes to the cellar stairs for a closer look. When he notices a shadow down the flight of stairs, he closes the basement door and tries to hold it shut, but something is pulling on it. After he screams for help, he runs directly into the demonic Freddy who says in a sinister voice: "Daddy can't help you now."
Freddy grabs him tightly by the shirt and threateningly strokes his forehead with his talons, demanding to use Jesse as a host body: "I need you, Jesse. We got special work to do here, you and me. You've got the body. (removing his hat) I've got the brain." There is no skull under Freddy's hat - only an ugly pulsating mass of bloody brain matter. Jesse wakes up with a blood-curdling scream from another "bad dream."
During his high school Biology class, Jesse verges on napping to catch up on his sleep deprivation. As he leans on his arm and appears to fall asleep, he dreams that a snake is wrapping itself around his neck - in reality, Grady has played a prank on him.
Later in the day, Jesse calls his friend Lisa and interrupts her swimming in the backyard pool of her luxurious home, but when he attempts to leave the house to see her and join her in the pool, Jesse's father demands that he first thoroughly unpack his bedroom. While cleaning up his room, he goes into a "Risky Business" performance routine. He is embarrassed when interrupted by his mother and Lisa who had been invited over to the house to help him unpack.
While helping him, Lisa discovers a tattered, five-year old red diary with a latched strap on the front, in the closet. They find that it belonged to Nancy Thompson, the previous occupant of the house - and room. She reads outloud portions of the diary, of Nancy's teenaged fantasies about her neighbor-boyfriend Glen: "His body is slim and smooth and I know I shouldn't watch him, but that part of me that wants him forces me to." Jesse sits down next to Lisa, turns a few pages, and begins reading another segment of the diary that equated teenage sexuality with horror.
Another entry tells about how she had an encounter with a different more monstrous male - Freddy: "March Fifteenth - He comes to me at night, horrible, ugly, and dirty, under the sheets with me, tearing at my nightgown with his steel claws. His name is Fred, and he keeps trying to take me to the boiler room. He wants to kill me." Nancy's nightmarish experiences and ordeals sounds chillingly familiar to Jesse, who appears stunned and frozen, realizing that the same stalker named Fred was also visiting him in his ongoing nightmares.
Lisa reads another troubling entry: "Tina is dead." Jesse recalls how Grady had told him about the previous occupant of the house, Nancy, who went crazy when she saw her boyfriend Glen murdered across the street. That night, Jesse tosses and turns as he begins to experience another bad dream: Jesse again awakes (misleadingly), sweating profusely in his very heated room.
A blue plastic baseball cap has melted, a candle next to him is drooping with melted wax covering part of his night-table, and an unsheathed long-playing record is hanging and bending over the edge of another dresser. He proceeds downstairs into the cellar where he opens the firebox on the furnace, reaches in, and pulls out a wrapped bundle - inside is a leather glove with a row of rusty knife blades protruding from the fingers.
Suddenly, flames burst from the furnace and he turned to see Freddy laughing at him, urging: "Go ahead, Jesse. Try it on for size. Kill for me." When Jesse tells Lisa about his dream at school the next day, she suggests he is having a premonition. On the high school practice field as they jog together, Jesse asks Grady if he remembers his dreams. He replies: "Only the wet ones." In the locker room afterwards, the coach hears them as they criticize him, concurring that he has "a stick up his ass" - the two are again punished by their coach with more push-ups.
That night in the Walsh house, roasting at about 97 degrees, the covered parakeet cage in the living room begins shaking, as one of the birds rips into the neck of a second bird and kills it. When Jesse opens the cage door, the bird flies into the room, circling around the ceiling, and dives at Mr. Walsh's left cheek - and puts a gash in it.
As they try to strike it down with a broom, the angry parakeet suddenly bursts into flames in mid-air. Mr. Walsh attempts to determine the rational cause of the aberration, either a gas leak or cheap bird seed, or even suspects sabotage by Jesse (with a planted cherry bomb).
During another disturbed night of sleep, Jesse experiences another frightening occurrence, in which Freddy takes over his body: Jesse goes downstairs to the kitchen, where a lightning bolt shatters the dishes drying on the countertop by the sink. Wearing pajamas, he wanders into the town of Springwood during a rainstorm, and enters a seedy bar with a flashing light announcing: DON'S PLACE.
It is a kinky, gay leather bar populated by prostitutes, gay couples, S&M devotees, etc. He passes by many of the patrons, two of whom (males) were kissing and biting each other. After he orders a beer, a hand grabs his wrist - it is Coach Schneider, dressed in a leather strapped vest tank top and tight pants, forbidding him to have an underaged drink.
In the next scene, Jesse is running laps around the school gym, and is then ordered to the showers by the coach. Meanwhile, in the coach's office, the strings on a tennis racket begin to supernaturally melt and snap, and a basketball falls off the equipment shelf and bounces around the room. After further shaking when the shelf appears to come alive, cans of tennis balls explode, and the coach is hit in the head by hurled sports equipment. As the coach crawls across the floor, two jump ropes wrap around each of his wrists and drags him protesting into the shower room.
Jesse watches in the steam-filled shower as the assaulted coach is tied to pipes, spread-eagled against the wall and invisibly stripped of his clothes. His bare butt is whipped by towels that have sprung to life, causing red welts. In the enveloping steam in the shower room, Freddy literally comes out of Jesse - he rips into the coach's back with his razor-bladed glove, causing four long bloody tears in his naked flesh. Blood flows from the shower nozzles. The coach is left limply hanging there, dead.
Our view returns to Jesse, who is wearing Freddy's glove. (Freddy had temporarily taken over his body.) He looks at the claw blades on his hand, and screams. Two police officers return Jesse (naked and wrapped in a blanket) to his home at 12:30 am, where his parents are told that Jesse was wandering around on the highway without clothes. His father suspects drug use. The next morning as he departs for school, Jesse tells his mother: "It's a problem I have to work out on my own."
His mother fears Jesse is crazy, certain that he needs professional help from a psychiatrist, although his father thinks he is a drug-user who needs more discipline. At school where officers have cordoned off the gym area, Jesse learns: "Schneider got wasted last night...Some maniac came in and sliced him up like a kilebasa. Hacked him in the shower, got bloody footprints all over the place." That night in his dresser drawer, Jesse finds the glove with the fingers moving and a voice summoning him to again be possessed and kill for Freddy: "Kill for me."