Nanodiamonds (NDs) have been widely explored for applications in drug delivery, optical bioimaging, sensors, quantum computing, and others. Room-temperature nanomanufacturing of NDs in open air using confined laser shock detonation (CLSD) emerges as a novel manufacturing strategy for ND fabrication. However, the fundamental process mechanism remains unclear. This work investigates the underlying mechanisms responsible for nanomanufacturing of NDs during CLSD with a focus on the laser-matter interaction, the role of the confining effect, and the graphite-to-diamond transition. Specifically, a first-principles model is integrated with a molecular dynamics simulation to describe the laser-induced thermo-hydrodynamic phenomena and the graphite-to-diamond phase transition during CLSD. The simulation results elucidate the confining effect in determining the material’s responses to laser irradiation in terms of the temporal and spatial evolutions of temperature, pressure, electron number density, and particle velocity. The integrated model demonstrates the capability of predicting the laser energy threshold for ND synthesis and the efficiency of ND nucleation under varying processing parameters. This research will provide significant insights into CLSD and advance this nanomanufacturing strategy for the fabrication of NDs and other high-temperature-high-pressure synthesized nanomaterials towards extensive applications.