This intriguing psychological thriller follows the adventures of a young couple, Ganga (Shobana) and Nakulan (Suresh Gopi), who arrive at the Nakulan's ancestral home tharavadu called Madampalli. Hailing from a family that follows tradition and superstitions, Nakulan's uncle Thampi (Nedumudi Venu) objects to the couple's idea of moving into the allegedly haunted mansion, which Nakulan ignores. The couple moves in, following which seemingly supernatural events begin to happen.
The mansion was occupied in ancient times by Sankaran Thampi, a cruel ancestor and karanavar (head) of the tharavadu. In his heyday, he had brought in a famous Bharatnatyam dancer Nagavalli from Tamil Nadu as his concubine. But she was already in love with a man named Ramanathan, a dancer. Learning of their affair and their plan to elope, Sanakaran Thampi murders Nagavalli in her room at the mansion.
Legend has it that on the eighth day of the Durgashtami (an annual Hindu celebration), Nagavalli returned as a blood-thirsty spirit, intent on killing the chieftain and to drink his blood, but he was saved by chanting some mantras. With the aid of some sorcerers, Thampi somehow escaped from the wrath of Nagavalli. Her spirit was locked up in a section at the mansion (Thekkini) by putting the talisman over the lock.
Later Sankaran Thampi committed suicide and his spirit is locked up in the same Thekkini, by means of an ornate enchanted lock called Manichitrathazhu (hence the title of the movie).
Ganga manages to unlock the Thekkini, only to find ancient valuables such as jewellery, musical instruments etc. Upon learning about the unlocking of the Thekkini, fearing the spirits are on the loose, Nakulan's uncle Thampi and family move in to the mansion to try and re-seal the Thekkini lock, while also looking out for Nakulan and Ganga.
However, various unclear sightings of a woman are witnessed around the mansion, along with attempted attacks on various people at the mansion, including Nakulan's cousin Alli and Ganga. While most of the family including Thampi believe that Nagavalli's ghost roams the mansion, Nakulan, disapproving of supernatural theories, suspects Sreedevi of being mentally ill, hence orchestrating the incidents at the mansion. Hearing of this, Thampi and the family fear that Sreedevi might be possessed by Nagavalli's spirit.
Sreedevi (Vinaya Prasad), Nakulan's cousin and Thampi's daughter, according to tradition, was to be married to Nakulan; however, after finding that Sreedevi had an ominous horoscope, Nakulan's mother withdrew from this proposal, and got Nakulan married to Ganga; later, Sreedevi entered a marriage which was short-lived. Sreedevi's tragic history, along with her perceived gloominess, and her being the only person present during an attack on Ganga, lays cause for suspicion of her.
Dr. Sunny Joseph (Mohanlal), a brilliant yet frolicsome Psychiatrist and Nakulan's close friend is called in to investigate. Soon enough Dr. Sunny finds out that Nakulan's conclusions are not as obvious and he uncovers a plan to commit a murder during the upcoming Durgashtami Festival. Sunny's trained psychiatric mind begins to suspect that Ganga could well be the mental patient of Madampilly.
He investigates Ganga's chidhood and past. Ganga grew up in a highly superstitious family and had partaken in various religious rituals as a child. Her parents had left her to her grandmother as a 3 year old and never bothered about her due to their busy lifestyle. This made her sensitive as an individual; so when she came to know that her parents were moving her to Calcutta she was unable to come to grips with it. She had become very close to her grandmother and didn't wanted to leave her village and her ancestral home.
It was a period of great emotional and psychological turmoil for her, and she became afflicted with multiple personality disorder. Madampilly with its share of superstitions and dark tales evokes memories of the childhood days in her, and she slowly develops the personality of Nagavalli after having sympathised with her.
Meanwhile, Nakulan's uncle, Thampi, having lost faith in Dr.Sunny, calls in a renowned tantric expert Pullattuparambil Brahmadattan Namboothiripad (Thilakan) to rid his family of the supernatural menace. As fate has it, both the Namboothirippad and Dr.Sunny are old acquaintances and mutually admire each others' expertise in their respective fields. At his own risk, Sunny reveals the secret to Nakulan and Mahadevan.
In one of the more memorable scenes of the movie, Ganga also gets to know about her illness during a manifestation of her hidden personality, that of Nagavalli. Sunny, with help of the Namboothirippad, plans an elaborate Tantric ceremony to invoke Ganga's Nagavalli persona and make it believe that it will finally be able to kill Sankaran Thampi. The plan is put into action and in a fiery climax, the blood thirsty Nagavalli exacts revenge on the cruel Karanavar, Sankaran Thampi.
Ganga wakes up from her hypnotic sleep and learns that she is completely cured of the illness. Sunny expresses his intent to marry Sridevi, and they all drive off happily.