In 1863, First Lieutenant John J. Dunbar (Kevin Costner) is injured in the American Civil War. Rather than having his foot amputated, he takes a horse up to the Confederate front lines. Distracted by Dunbar, the Confederates are routed as the Union army attacks. Dunbar is allowed to properly recover, receives a citation for bravery and is awarded Cisco, the horse who carried him, as well as his choice of posting. He requests a transfer to the frontier so he can see its vast terrain before the opportunity goes. Arriving at his new post, Fort Sedgwick, he finds it abandoned and in disrepair. He decides to man the post himself and begins rebuilding, preferring the solitude and recording his many observations in a journal. Dunbar also befriends an inquisitive wolf he names "Two Socks" for its white forepaws.

Dunbar initially encounters his neighbors, a Sioux tribe, when they attempt to steal his horse and intimidate him. In response, Dunbar decides to seek out their camp in an attempt to establish a dialogue. On his way he comes across a white tribe woman, Stands With A Fist (Mary McDonnell), who has injured herself in mourning of her deceased husband. She is the adopted daughter of the tribe's medicine man Kicking Bird (Graham Greene), as her white family was killed by the Pawnee tribe when she was young. Dunbar returns her to the Sioux to be treated, which changes their attitude toward him. Eventually, Dunbar establishes a rapport with Kicking Bird who equally wished to communicate. Initially the language barrier frustrates them, so Stands With A Fist acts as translator.

Dunbar becomes drawn to the lifestyle of the tribe and learns their language. He becomes an honored hero after locating a herd of buffalo and participates in the hunt. The Sioux observe Dunbar and Two Socks playing and promptly give him his Sioux name "Dances with Wolves". Dunbar also forges a romantic relationship with Stands With A Fist and helps defend the village from an attack by the Pawnee. Winning Kicking Bird's approval, he marries her and abandons Fort Sedgewick forever. Because of the growing Pawnee and white threat, Chief Ten Bears (Floyd Red Crow Westerman) decides to move the village to its winter camp. Dunbar decides to accompany them and returns to Fort Sedgwick to retrieve his journal. However, when he arrives he finds it occupied by the U.S. Army. Because of his Sioux clothing, the soldiers mistake him for a Native and open fire, killing Cisco and capturing him. When Dunbar's journal is unable to be found and he refuses to serve as an interpreter to the tribes, he is put on trial for treason and transported back east as prisoner.

While travelling in the armed caravan, the soldiers shoot and kill Two Socks when the wolf attempts to follow Dunbar. Eventually the Sioux ambush the convoy, killing the soldiers and freeing Dunbar. He decides to leave the Sioux with Stands With A Fist since his status will put the tribe in danger. After they leave, U.S. troops with Pawnee assistance reach the mountains but are unable to locate them, while a wolf howls in the distance. An epilogue states that 13 years later, the last remnants of free Sioux were subjugated to the American government, ending the conquest of the Western frontier states and the livelihoods of the tribes in the plains.

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