On a 2v2 fighting game, how do I make the players defend themselves?

If I understood correctly your issue is that when player1 is defending while pressing "X" you dont want him to get damaged?

By a quick look at your events, it looks like you are doing the opposite:

On P2 hit P1:

-wait 0.1

-Subtract 20

-And if the player1 is playing Defend: Substract another 5

That's a total of 25 you subtract when the player is playing defend

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So if you dont want to subtract while P1 is defending then the events should look something like this:

On P2 hit P1:

-wait 0.1

-If P1 is not Playing Defend: Subtract your Value + Flash