1. Prepare an image, can be JPG or PNG format. I suggest PNG format because its size will be smaller by a 4:1 ratio. It means that a 10 Kb JPG image will be a 2.5 Kb in PNG format. Also make sure the size is small like 20 x 20 pixels or less, so the file will be smaller in size and won't make your blog loads slower.
If it's difficult for you to edit a small image, you can make a bigger one first, like 200 x 200 pixels or more, and after finish, you can skew it smaller. Microsoft Paint can do it for you easily.
2. Upload the image to an image hosting service, like the free PhotoBucket. Then, obtain the direct link to your image for the next step. You can use another image hosting service if you like, just remember to get the direct link.
3. Add this bold tags to your template. To access it, click "edit html" in "layout" section. Put them in head section, between "title" tag and "b:skin" tag. If you face difficulties in finding the tag, just use the find tool in your browser. In Mozilla Firefox, the shortcut is ctrl+f. If you use another browsers, apply with adaptation.
<title><data:blog.pagetitle>
<link href='put the direct URL of your image here' rel='shortcut icon' type='image/vnd.microsoft.icon'/>
<b:skin>
Save and done! Visit your blog, open a few tab, and you should see your new icon there.
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