Sherlock (Benedict Cumberbatch) and John (Martin Freeman) receive a visit from Henry Knight (Russell Tovey), who witnessed his father's death by a "gigantic hound" at Dartmoor 20 years ago. After years of therapy, Henry visited the site again, only to see the hound again, prompting his request for help. Initially dismissive, Henry's use of "hound" instead of "dog" interests Sherlock. Sherlock and John arrive in Dartmoor to find the hound is a local legend. They visit Baskerville, a nearby Ministry of Defence research base, using Mycroft's (Mark Gatiss) security pass. After Mycroft's credentials cause a security alert, Dr. Robert Frankland (Clive Mantle) vouches for Sherlock's identity, despite knowing the truth. Frankland says he was a friend of Henry's father and is concerned for Henry's well-being.
Henry tells John and Sherlock about the words "Liberty" and "In" in his dreams. Sherlock, John, and Henry then visit the hollow in the hope of finding the hound. On the way, John notices what seems to be Morse code signals (these were unrelated; they were headlight flashes from a group of doggers). When Sherlock and Henry arrive at the hollow, they both see the hound. At a local inn, Sherlock is visibly shaken and confesses he saw the hound. John tries calming him, suggesting he's imagining things. Sherlock reacts with anger, denying there is anything wrong with him. John tries to interview Henry's therapist, Louise Mortimer (Sasha Behar). However, they are interrupted by Frankland, who blows his cover. Meanwhile, Henry hallucinates the hound is stalking his home.
The next morning Sherlock realises "hound" may be an acronym rather than a word. The pair run into DI Lestrade (Rupert Graves) who was sent by Mycroft to keep an eye on Sherlock. They interrogate the innkeepers about a past order for meat that John has spotted, which struck him as odd for a vegetarian restaurant. The innkeepers kept a dog on the moor to boost the tourist trade, but assure the investigators they had put it down. This explanation satisfies Lestrade but not Sherlock, who insists the dog he saw was monstrous. Calling Mycroft, Sherlock gains access to Baskerville again. Searching the lower levels of the genetics labs, John finds himself trapped and then hears growling which he assumes is the hound. Locking himself in an empty cage, he calls Sherlock, who rescues him. Sherlock deduces a chemical weapon designed to trigger violent hallucinations was responsible. Retreating into his "mind palace", a memory technique, Sherlock realises "Liberty" and "In" stands for Liberty, Indiana. After viewing confidential files, he sees "H.O.U.N.D." was a secret C.I.A. project aimed at creating a hallucinatory anti-personnel weapon, but the project was abandoned several years before. Sherlock realises Frankland, who participated in the project, has continued it in secret.
After John receives a call from Mortimer that Henry has run off with a gun, John, Sherlock and Lestrade run to the hollow to find Henry about to commit suicide. Sherlock explains the hound was an hallucination; his father was actually killed by Frankland, who was wearing a gas mask and a sweater with "H.O.U.N.D. Liberty, In" on it; a child couldn't cope with this, so his mind tricked him. Every time Henry came back, Frankland gassed him with the hallucinogen; the chemical agent is the fog they encountered at the hollow, triggered by pressure pads in the area. As Henry calms down, they all see the innkeepeers' dog; Lestrade shoots it. Sherlock finds and catches Frankland at the scene. Henry realises that Frankland murdered Henry's father, because he found him testing the drug. Frankland flees into the base's minefield and gets blown up. As Sherlock and John prepare to leave the next morning, John wonders why he saw the hound in the lab despite not having inhaled the gas from the hollow, but later realises Sherlock locked him in the labs in order to test his theory. He also points out Sherlock was wrong for once; he believed the drug was in Henry's sugar and put it in John's tea.
In the closing scenes, Mycroft oversees the release of Jim Moriarty (Andrew Scott) from a holding cell in which he has written Sherlock's name all over the walls.
