The HOSTS file is very similar to DNS. DNS converts hostnames (ex: bradcroft.com) to a numerical number called an IP address. DNS servers are located all throughout the internet including your own ISP. When you attempt to browse to a website your computer contacts the DNS server and the DNS server provides the IP address to the site, allowing your computer the knowledge on how to get to the site. If you modify your computers HOSTS file you can have your computer visit a different site entirely.
This is especially useful for malware prevention. There are several sites out there that have lists of different known malware sites. By modifying your own HOSTS file and putting in different IP addresses for these malicious sites you can help protect your computer.
The HOSTS file can be found on Windows in the C:\Windows\System32\drivers\etc\hosts and on Linux at /etc/hosts. To edit the file on Windows you will need to run the program as an administrator. I recommend using Notepad++ for editing text files.