"Technical" graphics (such as graphs and diagrams) are often labelled with quite complex mathematical expressions: there are few drawing or graphing tools that can do such things (the honourable exception being MetaPost, which allows you to program the labels, in (La)TeX, in the middle of specifying your graphic).
Labels on graphics produced by all those other tools is where
the psfrag package can help. Place an unique
text in your graphic, using the normal text features of your tool, and
you can ask psfrag to replace the text with arbitrary
(La)TeX material. Psfrag's "operative" command is
\psfrag{PS text}{Repl text}, which instructs
the system to replace the original ("PS") text with the
TeX-typeset replacement text. Optional
arguments permit adjustment of position, scale and rotation; full
details may be found in pfgguide in the distribution.
(Unfortunately, psfrag can't be used with PDFLaTeX,
though one might hope that it would be susceptible to the same sort of
treatment as is used in the pdftricks package. On the other
hand, VTeX's GeX processor explicitly deals
with psfrag, both in its free and commercial instances.)
Another useful approach is overpic, which overlays a
picture environment on a graphic included by use of
\includegraphics. This treatment lends itself to ready placement
of texts and the like on top of a graphic. The package can draw a
grid for planning your "attack"; the distribution comes with simple
examples.
Pstricks can of course do everything that overpic can, with all the flexibility of PostScript programming that it offers. The pstricks web site has a page of examples of labelling which will get you started; if pstricks is an option for you, this route is worth a try.
The confident user may, of course, do the whole job in a picture environment which itself includes the graphic. I would recommend overpic or the pstricks approach, but such things are plainly little more than a convenience over what is achievable with the do-it-yourself approach.
This question on the Web: http://www.tex.ac.uk/cgi-bin/texfaq2html?label=labelfig