Nadal ended Roger Federer's hopes of finishing a disappointing season on a high note, defeating the six-time champion 7-5, 6-3 in the other semifinal.
Unbeaten in his round-robin matches this week, the second-seeded Djokovic extended his winning streak to 21 matches since losing in the US Open final to Nadal. The two will play for the title Monday.
The world's two highest-ranked players are unbeaten in London this week and have faced each other five times this season, with Nadal winning three times.
After losing a set in each of his three previous matches, Djokovic raised his game Sunday by making only 14 unforced errors and breaking Wawrinka four times.
"The performance was definitely by far the best I've had in the tournament," said Djokovic, who is bidding for a third title at the elite event and has been the dominant player of the indoor season.
Nadal leads Djokovic 22-16, but the Serbian won their latest match last month in Beijing after losing his top ranking to the Spaniard.
Nadal, who claimed his first win over Federer on an indoor hard court, extended his winning record over Federer to 22-10 and has now beaten the Swiss on every surface. Federer had won their four previous matches at the ATP Finals, dropping only one set.
"The most important thing for me is (that indoor) is the toughest surface for me to play," Nadal said. "The most difficult for me was to be able to win four matches against top eight players. It's a very good way to finish the year."
Chasing his first title at the ATP Finals, Nadal played down the importance of the victory over his greatest rival.
"It is probably one of my best seasons," said Nadal, who reclaimed the No. 1 spot this year after coming back from a knee injury in February. "The most satisfying thing is always (to win) the tournament more than the personal victories. So for me it is more important to be in the final in the last tournament of the year than to have the chance to win against Roger."
Since he returned from his seven-month injury layoff, Nadal has produced one of the most impressive comebacks in tennis history. He has won 75 matches -- losing only six -- and captured 10 titles, including the French Open, the US Open and five Masters events.
Federer's season was far different. Hampered by a back injury, he won only one title in 2013 and was looking to take this event before the year-end break.
He played aggressively early on but faded after losing the first set, making too many mistakes to threaten Nadal.
"In the beginning, his serve worked very well," Nadal said. "My feeling is that in the first set, he played very well. He was closer than me to have the break. So in my opinion until 4-all, he was playing better than me."
Nadal and Federer treated the O2 Arena fans to superb exchanges, reminiscent of the classic matches that have makrked their nine-year rivalry. But Nadal was much sharper on the important points, converting all four break points he earned. Federer sometimes looked like a shadow of his old self, hitting 32 unforced errors and some poor volleys.
"I struggled to stay consistent enough throughout the match, and that's why he deserved to win" Federer said. "This game is a game of making or missing your opportunities. Today was a little bit more of that, again."
Federer, who beat Juan Martin del Potro on Saturday to qualify for the semis while Nadal had a rest day, looked tired toward the end.
He missed an early chance when he failed to convert three break points in the sixth game before Nadal took advantage of his first opportunity to break for 5-4 with a forehand winner.
Federer brought cheers from the crowd when he broke back immediately after winning a long rally with a forehand down the line and Nadal missed a forehand.
But Federer failed to build on the momentum, dropping his serve in the next game before going on to drop the set. He then struggled with his rhythm and was broken twice in the second set, with Nadal sealing the victory when Federer sent a volley long.
In doubles, three-time champions Bob and Mike Bryan advanced to the final after defeating No. 2 Alexander Peya and Bruno Soares 4-6, 6-4, 10-8. The top-seeded American twins will take on David Marrero and Fernando Verdasco on Monday after the Spanish duo beat Ivan Dodig and Marcelo Melo 7-6 (10), 7-5.
The Bryans have clinched the year-end No. 1 spot for a fifth straight year and a record ninth time. They have won 11 titles this season, including the Australian Open, French Open and Wimbledon.