After this funny cut-scene, go east, then south, and then east again. No way to pass there. Go west, then south, then west again. See the rock? Push it from the left, and discover a secret entrance. Go in it.
Go east, talk the almost-dead guy, go east again, and you'll see the ways. Go to the western one first, follow the path, take the potion and kill the pillbugs. Then go back, follow the other path, and you'll meet Graymore. Kill the 2 pillbugs and go west, where there's a useful red heart. Now go upstairs.
Go 2 screens west, burn the tree so as to pass through, see the automatic sequence: Dink surrender! Then go south, follow the path. You come in a new little island, where there's a healing well. Then go west until you find a castle. Enter it.
There're several things to do here: Go north to find a potion. Then go back, go south, the 2 screens west, and take the spirit bomb magic (it's a bit difficult to 'catch' it, but there's no bugs, the scroll can be taken). Go north, east, north again, and fight Graymore. Then go west: Dink is trapped here. Use the spirit bomb on the fence, and free Dink - don't use the fireball, I heard that there were a bug who freezes the game if you do so.
You're now automatically moved to another screen. From there, go east, enter the unlocked house, then go south killing the pillbugs, go upstairs. Watch the ending movie. Now Credits!