In prehistoric times, according to popular Chinese legend, a mysterious monster invaded a quiet village one wintry night, attacking villagers and destroying their homes and crops. The local sages demonstrated that the creature, which always came after the sun had shone 365 times, was afraid of three things: noise, bright lights, and the color red. So the villagers lit up their houses, painted things red, banged on drums and performed lion dances. And sure enough, the creature disappeared.

This Sunday, the legendary monster will once again be chased away by noise, bright lights and bright red as area Chinese and others gather in Washington's Chinatown to celebrate the Chinese New Year. The afternoon parade, fireworks, and various cultural activities, which every year sends thousands of visitors streaming into this usually quiet old neighborhood, marks the Chinese lunar year 4680, the Year of the Dog.

Actually, the new year officially began Monday, and many of the area's 30,000-40,000 ethnic Chinese have already begun celebrating the holiday in homes, churches, movie theaters and restaurants.

In homes, Chinese New Year's tradition calls for a host of colorful rituals that include honoring ancestors at a family altar, offering wine and candy to the kitchen god to gain his favor, and hanging up red scrolls inscribed with such sayings as, "Flowers will bloom, just like business" and "Follow your heart's wants."

But outside of Chinatown, Chinese culture is not particularly strong, partly because much of the local Chinese population is scattered throughout many suburban communities. Also, most suburban Chinese are of "the younger generation"--highly educated and Westernized professionals and government workers. So while most local Chinese mark the new year in one way or another, they celebrate it not as a time for traditional ritual, but as a special occasion for families to reunite and friends to catch up on each other's affairs over a huge New Year's meal. Not surprisingly, hundreds of Chinese flocked to grocery stores in Chinatown last week to buy supplies for their holiday fare.

For the few area Chinese who still consider the new year the most important day of the year, it is, above all else, a time for optimism and high hopes.

"Suppose you were sick last year . . . or you had bad business. . . . In the new year you wish you are strong and will have good business," said Alice Wang, 38, a congenial, talkative woman who owns three Chinatown businesses. One, Wang's Company, at Eighth and H streets NW, sells many New Year's items.

Wang, who describes herself as "old fashioned," hung red scrolls proclaiming prosperity and happiness in her Chinatown apartment, stayed up "until midnight" one day last week with her husband to bake special foods for the New Year's table, and gave lai see, small, red envelopes containing new dollar bills, to her children for their good fortune. She invited "everyone with the name Wang" to her New Year's Eve dinner. Wang says she does not know whether her children will keep the traditions she brought with her when she came to America from Shanghai by way of Hongkong in the 1960s. "But I want them to."

This year honors Tien Kou, who was, according to Chinese mythology, the trusty companion of the king of heaven's nephew. The Chinese Zodiac is based on a 12-year cycle, each year named after an animal, and those fortunate enough to be born in the Year of the Dog are thought to be honest, hard-working, peaceful and loyal, committed to justice and duty, and blessed with the ability to bring out the best in others.

The Year of the Dog finds Chinatown, a small pocket of turn-of-the-century row houses and family shops roughly bounded by G and I and Fifth and 10th streets NW, on the verge of what may prove to be the most decisive changes in years.

Wah Luck House, a 150-unit apartment complex built partly with funds from a block grant to the city, is expected to open its doors in early May. The complex was built primarily to house the hundreds of Chinatown residents displaced by construction of the city's new convention center at 10th and H streets. But while Chinatown leaders wanted Wah Luck house built in order preserve the neighborhood's Chinese character, the civic center's opening--scheduled for late 1982--may permanently change, and possibly erode, the neighborhood's identity.

But for now, Chinatown residents are preparing for this Sunday's celebration, which will begin at 1 p.m. with a parade at Ninth and H streets NW. Five Chinese dragons will cavort to the music of a Marine Corps band, the McKinley High School band, and the rattle of firecrackers. Martial arts demonstrations and Chinese dances will also be featured. The day will be capped at 5 p.m. with showings of Chinese movies at the Wah Shing martial arts school at Sixth and H streets NW. Mayor Marion Barry and other local politicians and leaders have accepted invitations to attend the celebration.