Headdy, the central protagonist of the game, is the star of the Treasure Theatre production of Dynamite Headdy. He has come to North Town from the country in order to visit his friends HeadCase, HangMan and Beau, but arrives to find that the evil puppet king Dark Demon is in the midst of attacking the puppet town to select which of the peaceful toys should live and which should be converted into his evil minions. Headdy is captured by the Robo-Collector and rejected by D.D.'s forces, and is dropped into the dust cargo to be thrown into the incinerator. However, Headdy escapes the clutches of Dark Demon's minions and sets off to defeat the evil king.
However, trouble is afoot. Not only is the puppet world filled with Dark Demon's minions, but to reach the evil overlord's castle Headdy must defeat Dark Demon's Keymasters, who serve as the king's elite guard. To make matters worse, Headdy is followed by his lifelong rival Trouble Bruin, a puppet jealous of Headdy's success. Bruin wants to be the star instead of Headdy, and will stop at nothing to get rid of him.