A teenage girl, Tina Grey (Amanda Wyss) has a disturbing nightmare in which she is stalked through a dark, neverending boiler room by a creepy, shadowy figure with a dirty red-and-green sweater, a battered hat, and a glove with razor-sharp knives for fingernails. Just as he catches her, however, she wakes up screaming, only to discover four razor cuts in her nightdress identical to the cuts in her dream. The next day, she finds out that her friend Nancy Thompson (Heather Langenkamp) had the same dream.
That night, Tina, Nancy and her boyfriend Glen Lantz (Johnny Depp) have a sleep-over to make a distraught Tina feel better. Tina's rebellious, on-and-off boyfriend Rod Lane (Nick Corri) crashes the party and goes to bed with Tina. However, Tina has another nightmare, and this time the killer catches her and brutally murders her. Rod wakes up to find Tina being cut open by invisible knives and then dragged across the ceiling. Rod is of course suspected of the killing and is arrested the next day.
Nancy then has three sadistically creepy, violent nightmares, in school, in the bath, and in her bed, where she is viciously stalked then attacked by the same terrifying figure who attacked Tina. These nightmares lead her to talk to Rod in prison, who tells her what he saw in Tina's bedroom. She becomes increasingly convinced that the figure appearing in her dreams is the person responsible for the killing of Tina, much to the dismay of her mother (Ronee Blakley). Nancy and a skeptical Glen rush to the police station late at night to talk to Rod, only to find that he's been strangled by his own bedsheets. It appears to everyone, except Nancy, to be a suicide.
Nancy's mother takes her to a Dream Therapy Clinic to ensure she gets some sleep. Once again, she has a horrendous nightmare. This time, her arm is badly cut, but she finds that she has brought something out from her dream: the killer's battered hat. It arouses concern, but also other feelings in Nancy's mother, who is clearly hiding a secret.
Eventually, Nancy's mother, increasingly drink-sodden, reveals to Nancy that the owner of the hat, and the killer, was a man called Fred Krueger, a child murderer who killed at least twenty children. Furious, vengeful parents burned him alive in his boiler room hideout when he was released from prison on a technicality. Now, it appears he is manipulating the dreams of their children to enact his revenge from beyond the grave. Nancy's mother, however, reassures Nancy that Krueger can't hurt anyone ("He's dead, honey, because Mommy killed him.")
Nancy devises a plan, with Glen, to catch Krueger, but Glen succumbs to sleep and is viciously killed by being sucked into his bed and shot back up in a fountain of blood and guts. Nancy faces Krueger on her own and succeeds in destroying him by turning her back on him and draining him of all energy.
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