If you ever have trouble in a fight, and don't know what to do, use travel mode. You can access it from the save screen menu to go back to earlier levels. Fight enemies to earn skill points, especially with Idrial's spirit powers. Check your stats to see your characters weaknesses, and use the appropiate elfstone(you may have to take them from other members of your group). Also, be sure you have plenty of kingsfoil, lembas, and elf medicine.
When battling the Balrog all of your party will be killed really quickly. To beat the Balrog I kept using Elf Medicine to revive my party members and used them to heal Gandalf.
Gandalf is the only one who can do significant damage to the Balrog so there really isn't any point in attacking with anyone else so just use the other characters to heal Gandalf and keep eachother alive. I beat the Balrog the first time I tried this method.