Recently I have been learning how to edit .nifs in Nifskope and modify .dds files with Gimp. My question is how does the image in the dds file know where to be applied to the armor in game? when looking at the dds file its the look of the armor or weapon but all torn up and fitted into a small space. Also if I create a new dds file for a mesh how do I get the image place on the right areas of the armor (ex. I want the shoulder plates of the armor or the blade of a weapon to be dark grey only and another area to be light brown and so on)

That is controlled by the model's UV map.

http://tesalliance.org/forums/index.php?/forum/118-graphic-artistry/, should be useful

Wow thank you so much! these lessons cover a few other questions i had as well.