When you are in the reply dialogue page there is an icon that opens the little box where you can insert the URL for your picture. The picture needs to be on a public web site. So your URL will be something like “http://www.mydomain.com”
your image will be something like myimage.jpg that would be the file name. so the entire URL will be “http://www.mydomain.com/myimage.jpg”
I see a lot of people using photobucket which frankly I can’t tell you anything about because I’ve never used it but presumably It’s the same sort of thing. For example I have a website called adlinda.com and I have some images on that web site so to see one of those images you just have to put the address complete with file name into a browser. http://www.adlinda.com/m1ascoped.jpg
If you put the address inside image tags which is what the little utility does it will pull the image into your post from your web site. I would put the image tags in this post but I think the server would parse the tags and try to find the image and not actually show you what the tags look like.