Watchmen is set in an alternate reality which closely mirrors the contemporary world of the 1980s; the primary difference being the presence of superheroes. The point of divergence occurred in the year 1938, and their existence in this version of America is shown to have dramatically affected and altered the outcomes of real-world events such as the Vietnam War and Richard Nixon's presidency. The only character who possesses obvious superhuman powers is Doctor Manhattan, whose existence has given the U.S. a strategic advantage over the Soviet Union, which has increased tensions between the two nations. Eventually, superheroes grow unpopular among the police and the public, which led to the passage of the Keene Act in 1977, a legislation to outlaw them. While many of the heroes retired, Dr. Manhattan and The Comedian operate as government-sanctioned agents, while Rorschach continues to operate outside the law.

In October 1985, New York City police detectives are investigating the murder of Edward Blake. With the police having no leads, costumed vigilante Rorschach decides to probe further. Discovering Blake to be the face behind The Comedian, a costumed hero employed by the U.S. government, Rorschach believes he has discovered a plot to terminate costumed heroes and sets about warning four of his retired comrades: Danny Dreiberg (formerly the second Nite Owl), the superpowered and emotionally detached Dr. Manhattan, his lover Laurie Juspeczyk (the second Silk Spectre), and Adrian Veidt (once the hero Ozymandias, but now a successful businessman).

After Blake's funeral, Dr. Manhattan is accused on national TV of being the cause of cancer in friends and former colleagues. The U.S. government takes the accusations seriously and Manhattan exiles himself to Mars. In doing so, he throws humanity into political turmoil, with the Soviet Union invading Afghanistan to capitalize on the perceived American weakness. Rorschach's paranoid beliefs appear vindicated when Adrian Veidt narrowly survives an assassination attempt, and Rorschach himself is framed for murdering Moloch, a former supervillain.

Neglected in her relationship with Manhattan, and no longer on government retainer, Juspeczyk stays with Dreiberg; they don their costumes and resume vigilante work while growing closer together. With Dreiberg starting to believe some aspects of Rorschach's theory, the pair decide to break him out of prison. Dr. Manhattan, after looking back on his own personal history, places the fate of his involvement with human affairs in Juspeczyk's hands. He teleports her to Mars to make the case for emotional investment. During the course of the argument, Juspeczyk is forced to come to terms with the fact that Blake, who once attempted to rape her mother, was actually her biological father following a second, consensual relationship. This discovery, reflecting the complexity of human emotions and relationships, re-sparks Doctor Manhattan's interest in humanity.

On Earth, Nite Owl and Rorschach continue to uncover the conspiracy surrounding The Comedian's death and the accusations that drove Manhattan into exile. They discover evidence that Adrian Veidt may be behind the plan. Rorschach writes his suspicions about Veidt in his journal, and mails it to New Frontiersman, a right-wing newspaper in New York. The pair then confront Veidt at his Antarctic retreat. Veidt explains his underlying plan is to save humanity from impending atomic war between the U.S. and the Soviets by faking an alien invasion in New York City, which will annihilate half the city's population. His hope: that this will unite the nations against a perceived common enemy. Moreover, he reveals that he murdered The Comedian, arranged for Dr. Manhattan's past associates to contract cancer, staged the attempt on his own life so as to place himself above suspicion, and eventually staged Moloch's death to frame Rorschach. Finding his logic callous and abhorrent, Dreiberg and Rorschach attempt to stop him but discover that Veidt had already enacted his plan.

When Dr. Manhattan and Juspeczyk arrive back on Earth, they are confronted by mass destruction and widescale death in New York City. Manhattan notices his abilities are limited by tachyons emanating from the Antarctic, and the pair teleport there, where they discover Veidt's involvement. Veidt shows everyone news broadcasts confirming the cessation of global hostilities and cooperation against a new threat, leading almost all present to agree that concealing Veidt's truth from the public is in the best interests of the world. Rorschach refuses to compromise and leaves, intent on revealing the truth. As he is making his way back, Manhattan vaporizes him. Manhattan then wanders through the base and finds Veidt, who asks Manhattan if he did the right thing in the end. "Nothing ever ends," Manhattan responds before leaving Earth for a different galaxy. Dreiberg and Juspeczyk go into hiding together under new identities. In New York, the editor at New Frontiersman complains about having to pull a two-page column about Russia due to the new political climate. He asks his assistant to find some filler material from the crank file, a collection of rejected submissions to the paper, many of which had not even been reviewed. The young man reaches towards the pile of discarded submissions, near the top of which is Rorschach's journal.