The plot of Fatal Fury centers around a martial arts tournament known as the "King of Fighters" tournament, held in the fictional American city of South Town and sponsored by local crime boss Geese Howard. Ten years prior to the events of the game, Geese murdered a rival martial artist named Jeff Bogard who was on his trail. Now, Jeff's adopted sons, Terry Bogard and Andy Bogard, along with their friend Joe Higashi, enter the tournament to get their revenge on Geese.
The gameplay follows the typical formula of most fighting games: the player competes against his opponent in best two-out-of-three matches. The play controls consist of an eight directional lever and three attack buttons: punch, kick and throw. As in the original Street Fighter, each of the playable character has special techniques that are performed by inputting specific commands and combinations with the joystick and buttons. The input methods for special moves are shown to the player during the course of the game (after every bonus round), as opposed to being given in an instruction card in the game's cabinet. The most novel aspect of Fatal Fury was the inclusion of a two-lane fighting system. The player can jump from one lane to another to avoid projectile attack or knock their opponent to the other plane.
When a second player joins during the middle of a fight, instead of postponing the current battle for a match between the two players, the game will make both players team-up against the current CPU opponent in a two-on-one match before their battle takes place. After every second match in the single player tournament, the player will participate in a bonus round mini-game involving an arm wrestling match against a machine. The player must tap the A button rapidly to win these mini-games.