If you’ve populated your fantastic tale with characters that the reader can believe in, and find interesting, and care about, you’ve already won half the battle. But you still have to decide on a setting for your story.
You could, of course, set your fantasy in the real world, or a reasonable facsimile thereof. Many writers have done this most effectively. Frank Belknap Long had fairies living in a New York City brownstone. And if you’re thinking of vacationing in H.P. Lovecraft’s picturesque seashore town of Kingsport, Massachusetts, don’t even think about climbing the Rock and trying to peek into the windows of The Strange High House in the Mist; and if you know what’s good for you, steer clear of The Terrible Old Man. These real world settings, in the hands of a skilled writer, help the reader to believe in the fantasy.
Or you could set your tale in the real world of the past, another time, another place. This isn’t done so often, because a historical novel is already a kind of escape for the reader. It’s a kind of time-travel, and fantastic in its own right. Among the few good examples of this that I can think of, L. Sprague DeCamp’s The Dragon at the Ishtar Gate, stands out. If you want to try this technique, good luck.
My own fantasies are of the “imaginary world” variety, for which J.R.R. Tolkien and his tales of Middle-Earth stand tall in a very numerous crowd. Here, you invent a world to house your story.
Another time, I’ll discuss how to go about doing this. It’s complicated. But the reasons for adopting this approach are simple; and the main reason is, it’s fun! Fun for the writer, fun for the reader. Unless you do it very badly: few things are quite as bad as a badly-done imaginary world.
I think the only thing more fun than reading Edgar Rice Burroughs’ novels of John Carter of Mars would be to write them in the first place. If you can study these, and Tolkien’s works, and come to understand how they did it–well, kimosabe, you’re in business. If you can learn from the great fantasy writers, then you’re ready to write fantasy.