The central twist of "Sherlock Jr." is that the entire adventure of the master detective is a dream. The film is split into two distinct parts: the real world and the dream world. In the real world, the Projectionist is a failure. He is framed for stealing a pocket watch by his rival, The Local Sheik, who pawns it and plants the ticket in the Projectionist's pocket. Believing him to be a thief, The Girl banishes him from her house.
Dejected, the Projectionist falls asleep in his booth, and his dream-self enters the movie being shown. In this film-within-a-film, he is the heroic Sherlock Jr., and the real-world characters are recast: The Girl is the damsel in distress, her father is a wealthy man, and The Sheik is the villain trying to steal a valuable pearl necklace. Sherlock Jr. brilliantly solves the crime, surviving numerous elaborate traps and engaging in a thrilling chase sequence. He ultimately rescues the girl and defeats the villain.
The resolution in the real world happens concurrently but entirely without the Projectionist's heroic intervention. The Girl, deciding to do some detective work of her own, goes to the pawn shop and discovers that it was The Sheik who pawned her father's watch. She goes to the theater to apologize to the Projectionist, waking him from his dream. The true hero of the real-world plot is The Girl. The final layer of meaning comes as the Projectionist, now reunited with The Girl but unsure how to act, looks to the movie screen for guidance, mimicking the on-screen hero's romantic advances to win his own happy ending, thus blending his cinematic fantasy with his reality.