Arrange your party so that the first line consists of two strong warriors, raistlin and goldmoon. This allows you to use Raistlin's magic and the healing staff of goldmoon without too much hassle. Save tanis and riverwind for the later levels, where the bows come in handy.
When fighting gully dwarves, use Tasslehoff who is the same height as them. His sling stones will never miss. Avoid fighting hatchlings, they're not worth it. Just turn and run when you meet one; when you reach an intersection move into a new path and wait a little. When you return, the hatchling will have gone.
They're easy to kill, so use a warrior.
A well-timed throw of an axe kills them every time. If you miss, use a sword and chest thrust movements. Don't let it get too close to you!
Use low thrusts to keep them at bay. If they get through your guard, retreat until you can turn and fight again.
The blue and green potions restore health, red slows down monsters, and yellow give your characters extra confidence.