Chip, yes, the photos must be on another website.
I'm not sure whether you want to post photos in the text of a post or do you want to put the picture to the left of your post. If to the left, go to your profile by clicking the Profile link at the top of the page, then put the url in the New Avatar box. You do not need any tags for this, just the url, starting with the
http://. For the Avatar Size, the first number is horizontal, the second is vertical. You want this to be in the same proportion as your picture. Max is 84. So, if your picture is 800x600 you'd want the first number to be 84 and the second number to be 3/4 of that (600/800). So it would be 84 x 63. Otherwise the picture will display scrunched up.
If you want the picture in the text of the post, use the Insert Image button you asked about. That will insert a pair of tags: [ img][ /img] but without the spaces I put in the tags so they'll display here. You put the url between the two tags. Include the entire path including the http:// part. If you are typing in the box at the bottom of the thread where the Insert Image button is not available, you can just type the img tags and url.
Hope this helps. If not, post back.