1

They are dancing in/on the glade.

Which preposition is correct?

Oxforddictionaries.com gives the following definition of the word:

An open space in a wood or forest.

So glade is a space, not a surface free from trees, and they are dancing in this space, not on the surface. Is it correct?

2

You are correct, one is

in a glade

since it surrounds you, similar to a valley. With both glades and valleys one can not be "on" them.

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