BLP and TGA files (only two accepted) need to have dimensions of power-of-two numbers (up to 2^10). By that I mean only 16, 32, 64, 128, 256, 512, and 1024 are valid as either width or height. They also must be in 256 colors (8 bits per pixel).
An image can be 32x512, but not 30x500. If you want a different part of it in game, then you take only a portion of that file using the <TexCoords> tag. If you want a different size, then you resize it (the selected area) with the <Size> tag. As a side note; I have files where half of the image file is unused, simply because it's width is a couple of pixels over a limit, and I had to use the next size up.
Here is a decent tutorial, though it is very old... Around page 6 or so it starts talking about textures.