As Avatar: The Way of Water opens, paraplegic marine Jake Sully (Sam Worthington) successfully inhabits the genetically engineered Na’vi avatar body into which his mind and memories were transported by the ceremony at the end of Avatar. Consequently, the film questions whether Jake is a human in a Na’vi avatar body, a Na’vi, or a human-Na’vi hybrid.

Jake and Neytiri (Zoe Saldaña) have two sons, Neteyam (Jamie Flatters) and Lo’ak (Britain Dalton), and a daughter, Tuk (Trinity Jo-Li Bliss). Since the death of Grace Augustine (Sigourney Weaver), Jake and Neytiri have become the guardians of Grace’s teenage daughter, Kiri (Sigourney Weaver). In addition, they have adopted Spider, a semi-wild human boy.

The family’s life is disrupted when the sky people return led by Colonel Miles Quaritch (Stephen Lang). Miles and his men inhabit Na’vi avatar bodies, and the Colonel blames Jake for the death of his human body and his new existence in a Na’vi body. Personally, the Colonel seeks revenge on Jake while the Colonel's mission for his troops is to find the source of Amrita, a natural resource from Pandora that stops aging.

Jake and Neytiri try to protect the Omaticaya clan and escape the Colonel and his men by leaving their rainforest home, where they live among Neytiri’s people. They flee to a remote reef inhabited by the Metkayina, Na’vi, with lighter blue skins that blend with the water. The Metkayina have developed a mystical art that allows them to exist underwater for extended periods.

The leaders of the Metkayina, Tonowari (Cliff Curtis) and Ronal (Kate Winslet), are reluctant to allow Jake and his family to stay. Tonowari is a family man, and he and his wife, Ronal, are concerned about the welfare of their family and their people. The couple finally decides to let Jake’s refugee family stay. Jake, Neytiri, and their children start to learn the ways of their new water world home.

The movie shifts focus to Jake and Neytiri’s children as they adjust to a new home that is so unlike the one where they expected to live. This opens the movie up to an exploration of Pandora’s water environment and allows viewers to discover it through the eyes of the children.

The story also focuses on the relationship between Jake and Neytiri’s children and the children of Tonowari and Ronal as it develops from hostility, rivalry, and bullying directed at the outsider or the other to acceptance and finally a cousin-like family relationship.

Eventually, Colonel Quaritch and his men discover that Amrita is extracted from the blubber of the ocean-dwelling tulkun. The friendliness of the whale-like mammals makes them easy to hunt. The Colonel and the corporation who hired him were prepared to kill the network of Pandora’s forests to obtain unobtanium, the energy source contained in the ground below the trees. Similarly, the Colonel and his new employer are prepared to hunt the tulkun into extinction to fulfill the demand for Amrita.

The hunt for the tulkun leads Colonel Quaritch and his men to the reef where Jake and his family are hiding among the Metkayina. With their hiding place discovered, Jake and the Na’vi join forces to again fight to protect the tulkun and all of Pandora and its resources.