In 1978, a serial killer, popularly nicknamed the Tooth Fairy, stalks and murders seemingly random families during sequential full moons. He first kills the Jacobi family in Birmingham, Alabama, then the Leeds family in Atlanta, Georgia. Two days after the Leeds murders, FBI agent Jack Crawford seeks out his protégé, Will Graham, a brilliant profiler who captured the serial killer Hannibal Lecter three years earlier, but retired after Lecter almost killed him. Graham is shown to have a remarkable visual memory as well as the ability to empathise with serial killers and had also shot the serial killer Garrett Jacob Hobbs. Crawford goes to Graham's Sugarloaf Key residence and pleads for his assistance; Graham reluctantly agrees. After visiting over the crime scenes with only minimal insight, he realizes that he must visit Lecter and seek his help in capturing the Tooth Fairy.

Graham visits Lecter at the Chesapeake Hospital where he is held. After a tense and unwelcome greeting by Fredrick Chilton, he finally meets Lecter. Lecter notices that Graham is still wearing the same aftershave he wore in court. He greets Graham and quickly works out that he is here to consult him on the Tooth Fairy murders. Lecter goads Graham on the true reason he has come here and requests to look at the case file. After examining the case, Lecter believes the killer is disfigured and smashes the mirrors in the houses so the victims can see him as he sees himself. Before Graham leaves, Lecter taunts him one last time, the reason Graham caught him is that "we're just alike".

The Tooth Fairy is revealed to be a St. Louis film processing technician named Francis Dolarhyde. He is a disturbed individual who is obsessed with the William Blake painting "The Great Red Dragon and the Woman Clothed in Sun ". Dolarhyde is unable to control his violent, sexual urges, and believes that murdering people—or "changing" them, as he calls it—allows him to more fully "become" an alternate personality he calls the "Great Red Dragon," after the dominant character in Blake's painting. Flashbacks reveal that his pathology is born from the systematic abuse he suffered as a child at the hands of both his sadistic grandmother and his stepfamily.

As Graham investigates the case, he is continuously hounded by Freddy Lounds, a sleazy tabloid reporter who had humiliated Graham by publishing photos of his wounds after the Lecter case. Meanwhile, Lecter's de facto jailer, Frederick Chilton, discovers a secret correspondence between Lecter and Dolarhyde, in which Lecter provides the killer with Graham's home address. Graham's wife and stepson are evacuated to a remote farm belonging to Crawford's brother. Graham tries to intercept the secret communication without Lecter's knowledge. Lecter is punished by having his privileges removed.

Lounds becomes aware of the correspondence and tries to trick Graham into revealing details of the investigation by posing as the Tooth Fairy, but is found out. Hoping to lure the Tooth Fairy into a trap, Graham gives Lounds an interview in which he blatantly mischaracterizes the killer as an impotant homosexual born of incest. This infuriates Dolarhyde, who kidnaps Lounds, forces him to recant the allegations, bites off his lips and sets him on fire, leaving his maimed body outside his newspaper's offices; Lounds eventually dies.

At about the same time, Dolarhyde falls in love with a blind co-worker named Reba McClane, which conflicts with his homicidal urges. In beginning a relationship with Reba, Dolarhyde starts to consciously resist the Dragon's "possession" of him; he goes to the Brooklyn Mansion, beats a museum secretary unconscious, and eats the original Blake watercolor of The Red Dragon.

Graham eventually realizes that the killer knew the layout of his victims' houses from their home movies, which he could only have seen if he worked for the film processing lab that developed them. Dolarhyde's job gives him access to all home movies that pass through the company. When he sees Graham interviewing his boss, Dolarhyde realizes that they are on to him and goes to see Reba one last time. He finds her talking to a co-worker, Ralph Mandy, whom she actually dislikes. Believing that Reba is being unfaithful, Dolarhyde kills Mandy, takes his body, kidnaps Reba and, having taken her to his house, sets the place on fire. He intends to kill her and then himself, but finds himself unable to shoot her. After Dolarhyde shoots himself, Reba escapes. Graham later comforts her, telling her that there is nothing wrong with her, and that the kindness and affection she showed Dolarhyde probably saved lives.

However, it turns out Dolarhyde did not in fact shoot himself but left behind the body of a gas station attendant, with whom he had previously had an altercation, in order to stage his own death. Dolarhyde attacks Graham at his Florida home, stabbing him in the face and permanently disfiguring him. Graham's wife, Molly, then fatally shoots Dolarhyde.

While recovering, Graham receives a letter from Lecter, which bids him well and hopes that he isn't "very ugly". It is implied that Molly's feelings toward Graham have changed, but the state of their relationship is not made clear. Graham has a flashback to a visit he made to Shiloh, the site of a major battle in the U.S. Civil War, shortly after apprehending (and in the process killing) Garrett Hobbs, a serial killer he investigated before he met Lecter.