Instructions
Download a character you want to include in your game. You can find these characters on several online databases, including Mugenation, Mugen Characters and Mugen-Infantry.
Unzip the file you downloaded using software such as 7Zip or WinRar. This brings up a window with package's contents.
Find the file that ends with the extension ".def." For instance, the file might be called "Ken.def."
Open you "Mugen" directory. The location of this directory will vary depending on where you unzipped your "Mugen" game to.
Open the "Chars" folder. Right-click and select "Create" and then "Folder." Name the folder after the ".def" file. For instance, if the file was "Ken.def," name the folder "Ken."
Drag and drop the contents of the zip file into your new folder.
Return to your "Mugen" root directory.
Right-click on "Select.def" and choose "Open with" and then "Notepad."
Scroll down to where it says "Insert your characters below." You'll see three entries that read "kfm.stages/kfm.def."
Replace one of the kfm entries with "[folder name].stages/kfm.def." For instance, if your folder name is Ken, it would read "Ken.stages/kfm.def" -- without the quotation marks.
Save and exit "Notepad." Your new character is now available from the character selection menu.