After Clicking Insert Image option, It will ask whether to add an image from computer or a web URL.Just give the location of the image.Once your image is uploaded, you can resize the image and position it by dragging it across your email.Since this is a labs edition feature, it is not enabled by default, you have to manually enable it by going to Gmail labs.

Note:

To protect you from spammers, Gmail doesn’t show URL-based images in messages by default.So if you are sending mail to other Gmail users, they will still have to click “Display images below” or “Always display images from …” to see images you embed.

Post from:

How to Insert Images in Gmail – A Gmail Labs feature