The little photo
icon you referred to is for hot-linking an image that's stored on a web hosting service
like Flickr or ImageShack. You can embed the image within the text using this approach, but the image has to be available to the Internet
with it's own URL.
If the image is stored on your own computer, click on the little "paper clip" icon and follow the prompts. The image, or images
, will be place below the text in your post, and can't be embedded within the text.