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The deserts of central Australia contain richer communities of lizards than any other arid regions, with the highest diversity occurring in sand dune habitats dominated by hummock-forming spinifex grasses. To investigate the mechanisms that permit coexistence, we studied two species of coexisting agamid lizards that exhibit striking divergence in their use of habitat in the Simpson Desert of central Australia. Here, the military dragon Ctenophorus isolepis is restricted primarily to sites providing > 30% cover of hard spinifex Triodia basedowii, whereas the central netted dragon C. nuchalis occurs in areas with much sparser (< 10%) cover. We constructed four mechanistic models to explain this pattern and then derived hypotheses to test them. One hypothesis, that competition restricts each species to its preferred habitat, was rejected after dyad encounters in field enclosures failed to elicit any habitat shift or any overt interactions between the species. Our next hypotheses were that each species exhibits preferences for different thermal environments or different prey types and that each selects the habitats that maximize access to them. Both were supported. C. isolepis preferred lower temperatures when active and specialized in eating ants < 5 mm long and selected spinifex-dominated areas where these requirements were met. In contrast, C. nuchalis preferred higher temperatures and a diversity of prey, both of which were available mostly in open areas. Finally, we used plasticine models to test the hypothesis that each species faced lower risk of predation in its selected habitat. This was partly supported, as models of both species were attacked more often in the open than under spinifex cover. The results show that habitat divergence occurs along several, probably covarying, niche axes. We suggest that different levels of spinifex cover provide the template for a broad range of ecological interactions, allowing lizard species to partition biotic and abiotic resources and achieve the extraordinarily high levels of local diversity that are observed.