Kristen Parker is a young girl who dreams herself into an abandoned house in Elm Street where she is chased by serial killer Freddy Krueger. She wakes up and goes to the bathroom, where she is attacked by Freddy again and slices her wrist with a straight razor. Believing her to be suicidal, her mother has her sent to Westin Hospital, run by Dr. Neil Gordon, where she fights against the orderlies who try to sedate her, for fear of falling asleep. She is eventually calmed by intern therapist Nancy Thompson who recites part of Freddy's nursery rhyme and earns her trust.
Nancy is introduced to the rest of the patients: Phillip, a habitual sleepwalker; Kincaid, a tough kid from the streets who is prone to violence; Jennifer, a hopeful television actress; Will, who is confined to a wheelchair after a suicide attempt; Taryn, a former drug addict; and Joey, who is too traumatized to speak. Later, Kristen is attacked by Freddy again (this time as a giant snake), and unwittingly pulls Nancy into her dream with her, allowing them both to escape. Kristen reveals she has had the ability to pull people into her dreams since she was a little girl. Over the next two nights, Freddy throws Phillip off a roof in what looks like a suicide attempt and kills Jennifer by smashing her head into a television that she was watching.
In their next group session, Nancy reveals to the remaining patients that they are the last surviving children of the people who banded together and burned Krueger to death many years ago. Nancy and Neil encourage them to try group hypnosis so that they can experience a shared dream and discover their dream powers. In the dream, Joey wanders off and is captured by Freddy, leaving him comatose in the real world; Nancy and Neil are fired. Neil is told by a nun, Sister Mary Helena, that Freddy is the son of a young nun who was accidentally locked in a room with hundreds of mental patients who raped her continually, and that the only way to stop him is to lay his bones to rest. He and Nancy go to her father, Don Thompson, to discover where the bones are hidden, but he is uncooperative. Nancy rushes back to the hospital after she hears Kristen is going to be sedated, while Neil convinces Thompson to help them.
Nancy and the others again go through group hypnosis so they can reunite with Kristen, but are all separated after Freddy interrupts them. Taryn and Will are subsequently killed by Freddy while Kirsten, Nancy, and Kincaid find one another. The trio rescue Joey but are unable to defeat Freddy, who has become too powerful because of all the souls he has consumed. However, Freddy senses that his remains have been found in an auto salvage yard and possesses his own skeleton to kill Thompson and incapacitate Neil. He returns to attack the others, but Joey uses his dream power voice to send him away. Thompson appears to Nancy to tell her that he is "crossing over", but he is revealed to be Freddy in disguise, who stabs and kills Nancy. As he is about to kill Kristen too, Nancy rises from behind and uses Freddy's own claws to stab himself, saving Kristen heroically. Neil awakens and consecrates the bones, finally destroying him. Nancy dies in Kristen's arms. At Nancy's funeral, Neil sees Mary Helena again and when he tries to follow her, finds her tombstone, revealing herself as Amanda Krueger, Freddy's mother.
Who was Nancy and the others trying to reunite with through hypnosis?
Kristen