Overclocking is the process of pushing to CPU to perform outside it's rated frequency.
This can be achieved by manipulating the FSB (Front Side Bus) and the CPU clock multiplier. When overclocking, you also have to push more power into the processor in order to function properly. This is achieved by increasing various voltage levels (usually just the north-bridge voltage and the CPU voltage). Failure to provide the CPU with enough power
For example:
My processor runs (stock) at 2.66GHz. My processor achieves this speed by multiplying the front side bus (266MHz) by the clock multiplier (x10). 266MHz x 10 = 2660MHz = 2.66GHz.
I overclocked my processor to run at 3.4GHz by increasing the front side bus to 425MHz and LOWERING the multiplier to 8. 425MHz x 8 = 3400MHz = 3.4GHz.
For my processor to run stable I had to increase the CPU voltage. My processor runs at a stock CPU voltage of 1.27v. For my processor to run stable I had to push more juice into the processor; I needed it to run at 1.42v. I reached this conclusion by using pure trial and error and a lot of testing using a program called Prime95**. This added power causes added heat. Those extra 0.15v that I set the power supply to supply to the processor created A LOT MORE HEAT. This heat was too much for my heatsink fan and I was forced to choose a much more optimal cooling solution.
All processors overclock differently, even if you're comparing two of the exact same model CPUs.
I can't push my processor too much further than 3.4GHz (on air cooling; I may be able to do so with water cooling solutions) but someone with the same processor as me (heck, they may even have the EXACT same hardware as me right down to the same BIOS version) and may be able to push the CPU to 4GHz on air cooling. ALL chips (processors) vary in how well the overclock. I must note that overclocking ANY COMPONENT decreases it's life span, because it's not meant to run at the speed it's being forced to run at.
Many people overclock to save money. For example, The difference between some of the Phenom II X4 processors (made by AMD) differ only in clock speed. Some people will purchase a slower, cheaper model and overclock it to perform on par or BETTER than the much more expensive models.
**Prime95 pushes the CPU to its limits. All cores are pushed to 100%, testing various complex calculations, involving mersenne prime numbers. Basically, it tests to see if the processor can perform complex mathmatical computations. If the test expects 2^4 to equal 16, and the processor returns the answer as 15, whichever core processed that calculation gets shut down, and the CPU fails the test. While this doesn't seem too bad, it is very bad. Errors such as this could cause the computer to crash, and often. If it passes for an extended period of time, it's deemed "stable".