KnitPicks website regarding multi color knitting. You can click here to go straight to the their file and then download it for your own future reference. It is complete with a photo tutorial as well. Here is the verbiage from their file and it is just awesome.
Tame Multi Color Knitting
Working with more than one color is not as difficult as you might think once you adopt a technique that feels comfortable. Keeping your colors organized and finding a way to hold the yarn so that the yarn doesn’t twist or get tangled is key to working with multiple colors. Here are some methods to experiment with to help make your color work more enjoyable.
Carrying Two Colors
For the knitter whose primary style of knitting is left handed (or European) both colors can be carried on the left hand. This technique is also referred to as “true” Fair Isle, from the island located between Scotland and Norway where the intricate Fair Isle style of knitting with multiple colors originated. With this system, the knitter can carry both colors over the left index finger, “picking” the color needed with the right needle tip.
Using a Yarn Guide
Whether you knit with the yarn in the left or right hand, it can be tricky to keep the two colors separate. There is a device known as a Yarn Guide which serves as a useful tool in keeping the two colors apart. This clever piece of knitting gear can be used on either the right or left index finger.
1. Carry the strands of unused color LOOSELY in the back of the project. Loose stitches or strands can be tightened but it is virtually impossible to loosen stitches that are too tight and they will cause unsightly puckering on the right side of your project and may even affect the fit.
2. Choose lighter weight yarns that can be doubled—fingering, sport and DK are ideal weights for stranded color work.
3. Bear in mind that your finished project will be quite warm because of the two layers.
4. For color patterns which involve 3 or more stitches of one color in a row, be sure to wrap the unused yarn in the back of the work.
5. Color work is easiest worked in the round, on circular needles or double point needles employing steeks where necessary to create openings for the armholes, neck and cardigan button/zipper bands. It is difficult to purl two color work, carrying the yarn in the front of the work. Hats make an excellent small, first project for stranded color work.
Handy Tips When Working With Color
Many knitters happily use a technique which combines the best of left-handed knitting and right-handed knitting to quickly work with two colors. This is the system endorsed by Elizabeth Zimmerman in Knitting Without Tears. The key to this method is organizing your yarn, keeping one ball on your right side of you and the other on your left. You should hold the main color in whichever hand you feel the most comfortable.
The following technique is used when you have a pattern which calls for more than 2 stitches of the same color from the RIGHT HAND.
The first stitch of the color is knit normally; the next stitch you will want to weave. Put your needle into the stitch and under the yarn on the left hand. Proceed to knit your stitch with the right color as normal. You have essentially lifted the left hand color over the right. Alternate a normal stitch with a woven stitch; the woven stitch can be every other stitch or every third stitch. However, do not knit woven stitches back to back. Be sure to put an “ordinary” stitch in between or the weaving won’t work.
Wrapping the Yarn While You Knit
For a tidy look in the back of the work, securing loose strands or “floats”, consider “wrapping” the two colors while knitting. There are two commonly used techniques for wrapping the unused color behind your work while you are knitting your multi-color project. With a little practice, you can master these techniques and they will become indispensable in working with color patterns.
The following technique is used when you have a pattern which calls for more than 2 stitches of the same color from the LEFT HAND.
Here’s how it works: pretend to knit with your right hand, wrapping the right hand color around the needle as if to knit it (but don’t). Immediately after that, pretend to knit with your left hand by picking up the color in the left hand with the right needle tip. Then unwrap your right hand color and bring the left color stitch through. Do not weave two stitches in a row. Be sure to put an “ordinary” stitch in between or the weaving won’t work.
Note: If your stitches are twisted then you are bringing the yarn through the wrong way