Develop an outline of the plot from start to finish. This gives you an idea of the type of characters you will need, their educational background and skills. It also helps you develop where the story is going to take place. For example, a story about an evil warlord taking over a country won't take place in space.
Create your protagonist and antagonist first, as they are your most important focal characters. Research the time period of the story to get an idea of the various skills and education each might have. For example, the evil overlord will have significantly more education and skills than a farmhand. A farmhand will know how to use a scythe with proficiency more than he would know how to use a sword or an axe.
Discover the motivations of the characters for going on the journey in the story. For example, the main character should react to the actions of the protagonist. Such as, the evil overlord kidnaps the protagonist's wife and burns his village. This also helps develop emotional stakes, as the protagonist is now angry, and is determined to defeat the evil overlord.
Determine who will be the secondary characters, such as the love interest, friends and companions. They will not have as detailed a personality and history as your main characters, but they should be detailed, so their actions match their personality.
Imagine where each of the characters will live, and revisit the plot outline and imagine the best place for the big battle or the ending confrontation. The setting should reasonably reflect the time period and backgrounds of the characters. For example, the farmhand should live on a farm in a small town, instead of a bustling city. He can always visit a city, but then the prose should reflect his awkwardness.
Write out the scenery for each major scene in the story, and be as detailed as possible. Discuss the color of bricks in the castle, the ornate tapestries, or the smell of the farm and the sound of the animals. A story paints a picture and the scenery makes up a large portion of that picture.