Labels are a way to easily categorize your posts. When you're writing a post, click Labels on the side and enter the labels you like, separating them with commas. Labels you've used before will show up below, and you can just click them to add them to the post.
When you publish your post, the labels will be listed with it. Clicking any of the labels will take you to a page containing only posts with that label.
You can easily change the formatting used here by editing your blog's layout. You can also add a list of all your labels in the sidebar of your blog, sorted alphabetically or by frequency of use.
Labels are handy if you blog about a lot of different subjects, since readers can then choose to view all of your posts on, say, dancing at once. Or politics, or knitting, or whatever you happen to be writing about. If you have a team blog, you could also give each member their own label, so you could easily read all the posts by any one of them. Feel free to come up with other creative new uses as well!
Note: The following characters cannot be used in labels: