basically blocking the nerves in the horses leg to find out where a problem may be. They usually start at the foot and work their way up the leg, trotting the horse up each time. When the horse trots up sound, they have found where the problem is....
As Jumpthemoon said, it's basically detective work to work out where a problem is/isn't as the horse can't point to the bit where it hurts most.
The vet will start at the bottom of the leg and work up, injecting local anaesthetic into various nerve points. The horse needs to be noticeably (and not intermittently) lame before it will work - you need to be able to see a definite improvement in the gait which is definitely related to the nerve blocking and not some random other factor. Basically the vet combines the result of the nerve block (i.e. where the horse comes sound) with their knowledge of anatomy (and particularly where the nerves are) to locate the area of pain which is causing the lameness. This may be used to eliminate problems and/or locate where you need to scan.
Nerve blocking is also not advisable where there is a possibility of a fracture - need to rule that out by x-ray first.
Some blocks are more specific that others, and some are more difficult than others.