The film features various people involved in the motion picture industry playing themselves, including actress Heather Langenkamp, who is compelled by events in the narrative to reprise her role as Nancy Thompson. New Nightmare features several homages to the original film such as quotes and recreations of the most famous scenes.
Heather Langenkamp lives in Los Angeles, California, with her husband Chase and their young son Dylan. She has become popular thanks to her role as Nancy Thompson from the Nightmare on Elm Street film series. One night she has a nightmare that her family is attacked by a set of animated Krueger claws from an upcoming Nightmare film, where two workers are brutally murdered on set. Waking up to an earthquake, she spies a cut on Chase's finger exactly like the one he had received in her dream, but she quickly dismisses the notion it was caused by the claws.
Heather receives a call from an obsessed fan who quotes Freddy Kruger's nursery rhyme in an eerie, Freddy-like voice. This coincides with a meeting she has with New Line Cinema where she is pitched the idea to reprise her role as Nancy in a new Nightmare film which, unbeknownst to her, Chase has been working on. When she returns home, she sees Dylan watching her original film. When she interrupts him, he has a severely traumatizing episode where he screams at her. The frequent calls, and Dylan's strange behavior, cause her to call Chase. He agrees to rush home from his workplace as the two men from the opening dream did not report in for work. But Chase falls asleep while driving and is slashed by Freddy's claw and dies. His death seems to affect Dylan even further, which causes concern for Heather's long-time friend and former costar John Saxon. He suggests she seek medical attention for Dylan and herself after she has a nightmare at Chase's funeral in which Freddy tries to take Dylan away.
Dylan's health continues to deteriorate. He becomes increasingly paranoid about going to sleep, and fears Freddy Krueger, even though Heather has never shown Dylan her films. She visits Wes Craven, who suggests that Freddy is a supernatural entity drawn to his films, freed after the film series ended with the release of Freddy's Dead: The Final Nightmare. It now focuses on Heather, as Nancy, its primary foe. Robert Englund also has a strange knowledge of it, describing the new Freddy to Heather, then disappearing from all contact shortly after. Following another earthquake, Heather takes a traumatized Dylan to the hospital, where the head nurse, suspecting abuse, suggests he remain under observation. Heather returns home for Dylan's stuffed dinosaur while his babysitter Julie tries unsuccessfully to keep the nurses from sedating the sleep-deprived boy. Dylan falls asleep from the sedative. Freddy brutally kills Julie in Dylan's dream. Capable of sleepwalking, Dylan leaves the hospital of his own accord while Heather chases him home across the interstate as Freddy taunts him and dangles him before traffic. On returning home, Heather realizes that John Saxon has established his persona as Don Thompson. When Heather embraces Nancy's role, Freddy emerges completely into reality and takes Dylan to his world. Heather finds a trail of Dylan's sleeping pills and follows him to a dark underworld. Freddy fights off Heather and chases Dylan into an oven. Dylan escapes the oven, doubles back to Heather, and together they push Freddy into the oven and light it. This destroys both the monster and his reality.
Dylan and Heather emerge from under his blankets, and Heather finds a copy of the film's events in a screenplay at the foot of the bed. Inside is written thanks from Wes for defeating Freddy and playing Nancy one last time. Her victory helps to imprison the entity of the film franchise's fictitious world once more. Dylan asks if it is a story, and Heather agrees that it is before opening the script and reading from its pages to her son.
Written under the working title A Nightmare on Elm Street 7: The Ascension, Wes Craven set out to make a deliberately more cerebral film than recent entries to the franchise—which he regarded as cartoonish and not faithful to his original themes. The basic premise originated when Craven first signed on to co-write Dream Warriors, but New Line Cinema rejected it then.
In New Nightmare, Krueger was portrayed closer to what Craven had imagined: darker and less comical. To reinforce this, the character's make-up and outfit were enhanced, with one of the most prominent differences being that he now wears a long blue/black trenchcoat. In addition, the signature glove was redesigned for a more organic look, with the fingers resembling bones and having muscle textures in between. While Robert Englund again plays the character, "Freddy Krueger" is credited as "Himself" in the end credits.
Craven had intended to ask Johnny Depp, whose feature film debut was in the first film, to make an appearance as himself, but was too timid to ask him. Upon running into each other after the film's release, Depp said he would have been happy to do it.
On Rotten Tomatoes, 78% of 36 surveyed critics gave the film a positive review; the average rating is 6.5/10. Several critics have subsequently said that New Nightmare could be regarded as a prelude to the Scream series—both sets of films deal with the idea of bringing horror films to "real life".
Roger Ebert of the Chicago Sun-Times gave New Nightmare three stars out of four and said, "I haven't been exactly a fan of the Nightmare series, but I found this movie, with its unsettling questions about the effect of horror on those who create it, strangely intriguing." Kevin Sommerfield from the horror website Slasher Studios gave it four out of four stars and said, "New Nightmare is that rare horror film in which everything works. The performances are pitch perfect, led by a tour-de-force performance by the amazing Langenkamp. The script has many twists and turns and the movie is quite possibly the best looking of the entire series."
However, Entertainment Weekly's Owen Gleiberman gave New Nightmare a negative review, stating:
After a good, gory opening, in which Freddy's glove—newly designed with sinews and muscles—slashes the throat of the special-effects guy who's been working on it, the movie succumbs to a kind of sterile inertia. Wes Craven's New Nightmare isn't about Freddy haunting a film set, which actually might have been fun. It's about Heather Langenkamp, star of the original Nightmare on Elm Street, being menaced for two long, slow hours by earthquakes, cracks in the wall, and other weary portents of doom.
Gleiberman described the film as "just an empty hall of mirrors" that "lacks the trancelike dread of the original" and the "ingeniously demented special effects" of Dream Warriors.