Magic Pengel is centered on the player, as a character able to manipulate a "Pengel" (which looks like a stylized fairy combined with a paintbrush) to create a creature, or "Doodle". Using the Pengel (pronounced "pen-jell") as a cursor, the player simply sketches out the limbs, body, and other features. Depending on the amount of magic ink expended, and the types of body parts, the creature will be given certain statistics and created. With the help of Zoe and Taro, the character trains and battles using custom-created designs, which can be traded to or battled with the creations of other players. As the Doodles battle, they become more powerful, and earn points towards the purchase of pre-created Doodles, and extra abilities towards customizable creation. Combat functions according to three selections: attack, magic, and block, as well as a charge command. The three basic maneuvers follow a standard rock-paper-scissors methodology, but repetitiveness is minimized due to the varied attributes of the Doodles, as well as the inability to successively repeat any selection.

The story begins when you (the main character - this character is never shown or given a default name in order to keep with the "second person" feel of the game, however, it is implied that the unseen character is a young boy) wake up in someone's yard and sees a Pengel. A mysterious voice tells you that you can use the Pengel to draw whatever you like, and that the shape will become your companion on your quest. You draw a simple shape to become your first Doodle, however, the Doodle falls off a cliff and is rescued by a girl. Then it runs away. After lecturing you, the girl introduces herself as Zoe, then introduces her (foster) brother, Taro. She takes you to the arena where a tournament is being held and teaches you how to duel. You win, and Zoe gets ticked off at the kingdom's guards for taking some of the Color you won as tax.

It is revealed that the King who rules the humans is corrupt and tries to force pure-hearted people to draw Doodles to work for him. One of his best Doodlers, Galileo (who is Zoe and Taro's father) disappeared and the king has been trying to seek revenge by taking away Zoe and Taro's homeland. Zoe and Taro don't know where Galileo went, and have been searching for their father by throwing notes in a bottle into the ocean. You must enter tournaments to get the money Zoey and Taro need to pay off the mortgage on their Homeland, help them search for their father, and eventually defeat the Doodle King himself.