Yea, that is not explained in simple terms because it's not simple.

First thing you need is to call TinyMCE with its complete bundled plugins, by inserting in the header

<script language="javascript" type="text/javascript" src="http://./tiny_mce/tiny_mce.js">

<script language="javascript" type="text/javascript">
tinyMCE.init({
mode : "exact",
elements : "mycontent",
theme : "advanced",
language : "en",
plugins : "safari,pagebreak,style,layer,table,save,advhr,advimage,advlink,emotions,iespell,inlinepopups,insertdatetime,preview,media,searchreplace,print,contextmenu,paste,directionality,fullscreen,noneditable,visualchars,nonbreaking,xhtmlxtras,template",
theme_advanced_buttons1 : "bold,italic,underline,strikethrough,|,justifyleft,justifycenter,justifyright,justifyfull,styleselect,formatselect,fontselect,fontsizeselect",
theme_advanced_buttons2 : "paste,pastetext,pasteword,|,bullist,numlist,|,outdent,indent,blockquote,|,undo,redo,|,link,unlink,anchor,image,cleanup,help,code,|,preview,|,forecolor,backcolor",
theme_advanced_buttons3 : "tablecontrols,|,removeformat,visualaid,|,sub,sup,|,charmap,iespell,media,advhr,|,ltr,rtl",
theme_advanced_buttons4 : "insertlayer,moveforward,movebackward,absolute,|,styleprops,|,cite,abbr,acronym,del,ins,attribs,|,visualchars,nonbreaking,pagebreak,|,fullscreen",
theme_advanced_toolbar_location : "top",
theme_advanced_toolbar_align : "left",
theme_advanced_statusbar_location : "bottom",
theme_advanced_resizing : true,
theme_advanced_resize_horizontal : true,
content_css : "./css/lightneasy.css",
extended_valid_elements : "hr[class|width|size|noshade],font[face|size|color|style],span[class|align|style],a[name|href|target|title|onclick],img[class|src|border=0|alt|title|hspace|vspace|width|height|align|onmouseover|onmouseout|name]",
external_link_list_url : "example_link_list.js",

external_image_list_url : "image_list.js",

flash_external_list_url : "example_flash_list.js",

file_browser_callback : "fileBrowserCallBack" });
function toggleEditor(id) {
var elm = document.getElementById(id);
if (tinyMCE.getInstanceById(id) == null)
tinyMCE.execCommand("mceAddControl", false, id);
else
tinyMCE.execCommand("mceRemoveControl", false, id);
}

If you don't want to include all plugins, just remove the plugin AND the respective button(s) from the listing above.

You can see here the command external_image_list_url : "./images/image_list.js", which defines the image list that will appear in a drop-down box in TinyMCE images dialog box. You can edit it so see its format.

The other is inputting the url to the image directly in the images dialog box.

But, in both cases, the image needs to be uploaded previously to the host and image_list.js updated (if you are intending to use it). TinyMCE doesn't do it on its own, so you need to have it done from outside TinyMCE.

try "./example.jpg"