First you will need a image editor like Paint Shop Pro (psp for short).  You can get that here

Once you have set it up you will then need to choose the picture that you want to make a av out of.  Clear pictures are best.  If you start with a grainy picture that is very large it's going to come out even worse in smaller size.  If you are scanning your pictures for use, then have your scanner set to a small size and it should be clearer when you start reducing.

Open your picture using the file menu or the little button that looks like this 

(this is a bit smaller than the actual size for the sake of loading times)

In the lower right corner of the screen will be the size of the picture.  This will let you know how much you are going to need to cut out to make your avatar.  In this case the picture is 640 X 400.  We will have to do ALOT of cutting since Avatars are 48 X 64 pixels.

You will first need to click on the cutting tool   With this you will be able to take out the areas of the picture you dont want in the avatar.    Once you have outlined the area you want to make the av out of (It will have a blinking, broken black (or white) line around it.) You will need to go to the edit menu at the top of the screen and click on cut.  This is going to leave a gapping hole in the picture..BUT DONT WORRY, you havent done anything wrong.
(after the cut)

Now using the edit menu again at the top of the screen, you will need to click on paste and then slide it over to "as a new image".
(reduced screen shot of picture after first paste)

Now here comes the fun part.  This is the true test of if you have a picture that can be used as a av.  This image is still over 330 pixels wide..thats way too big yet, so we will have to do some resizing.  Under the image window at the top of your screen is the option to resize.  Put in 48 as the first area, then just click on the next to see how you measure up.  Mine is comming up only 58 long where it is supposed to be 64, so we would use 64 as the measurement.  Now it's going to be off on the first measurement, but dont panic.  You can do a bit more cutting to make it measure right.  Go ahead though and resize your image closest to 48 X64 that you can get it (dont unclick "maintain aspect ration" though unless you want a squashed looking av)

(reduced size screen shot of after the resizing)

Now you might have some little bits to trim off.  Run your mouse over the picture and check the size in the lower right corner of your screen.  Mine is measuring 53 X 64 so I need to trim off 5 pixels in width.  No big deal, just click on the cutting button again and watch the third set of numbers on the bottom left as you are dragging your mouse.  Those are telling you the area inside the cut and you can actually make avs out of smaller pictures just from watching those numbers.  Once you have the area right inside there double check your cut and see if you have all the important elements of the avatar inside the cut area.  If you dont, try cutting again from a different angle or spot.  Remember the correct size of a avatar is 48 X64 pixels.  Anything above that will NOT work.  Anything under that shows to others as gapping spaces surrounding your av.

This is the Avatar I just made.

The quality isnt the greatest because of the huge size of the inital picture.  One last note.  You must save the avatars in the .gif format for them to work.  They need to go into your Gallery folder, you can find this under C:\PROGRAM FILES\VPLACES\EXTS\GALLERY.

So in wrap up...
1.  Choose your picture and open it.
2.  Cut the size into roughly the shape of a avatar (rectangular, long side going down)
3.  Resize your avatar to as close to 48 X 64 pixels as possible.
4.  Cut more if needed.
5.  Save in .gif format.
 
Here are some helpful sizes for you.
Avatars = 48 X 64 pixels
Large Tour = 144 X 62
Small Tour = 50 X 40

If I did my job right then you should know how to make avatars now.  If you dont, read this again and again until it makes sense (LOL, sorry couldnt resist).  Goodluck and happy Avatar making.