Firstly, you have to have the photo on a server somewhere on the web. I have some space at inetsonic.com so I stash a bunch of my stuff there (including my web site about Tutankhamon).
I ftp the photos there and then push the image button above the post typing box. I enter the internet address there: "http://www.inetsonic/com/kate/stuff/some.jpg
You don't have to have dynamic image posting enabled. I haven't any idea what that is. anyone?