For a chisel, plane or gouge to cut correctly, it goes without saying that the tool must be properly sharpened. A dull tool doesn't cut cleanly, but instead tears at the wood fibers. The result isn't a clean, attractive and accurate cut, but a fuzzy, uneven, unprofessional look. This means that you must put more effort into getting the tool through the wood, which makes the task more dangerous. It also means that it probably took longer to complete the task. Once you learn how to properly sharpen your tools, you'll never need to work with a dull chisel or gouge again.
The first step to sharpening any tool, particularly one that has been chipped or abused, is to grind the face(s). Grinding your tool will remove a lot of material in a hurry, but it is a necessary step to cleaning up the faces of a worn-out tool.
There are typically three types of tools used for grinding: the bench grinder, the wet grinder and in a pinch, even a belt sander. Simply hold the face of the tool flat against the surface of the grinding tool, with the motion of the grinding tool in the same direction as the you would use when cutting with the gouge or chisel. Do not grind across the face of the bevel.
When grinding, particularly with a bench grinder or belt sander, be sure to avoid letting the tool get too hot. Excessive heating while grinding will cause the tool to lose temper, which is the method used in manufacturing that helps harden the tool and allow it to keep it's edge longer when in use. To combat overheating when grinding, keep a cup or pan of cool water nearby. Grind in bursts of 2-3 seconds at a time, then dip the tool in water if it starts to build up heat.
This is one of the benefits of a wet grinder. The water in the stone's reservoir keeps the stone and tool cool while grinding.
Grinding using one of the aforementioned methods will remove a lot of material from the face of the tool, but it also will leave grooves in the face of the tool. These grooves need to be removed for the tool to be truly sharp. Honing is the step for removing these grooves, and for getting the tool 95% of the way to being ready to use.
There are a number of methods for honing, but perhaps the most tried-and-true method is to use a flat wet stone or oil stone. The water or oil on the stone is for lubrication between the face of the tool and the stone, which again will help to reduce heat in the tool
For fine woodworking, I'd recommend a wet stone, as oil from an oil stone may cause problems with your finish later in the project. Simply get the stone as wet as possible, and place the beveled edge of the tool flat on the top surface of the stone. Keeping the beveled angle consistent, work in a figure-eight fashion until all of the grooves on the bevel are removed.
Then, run your finger along the back-side of the cutting edge. You should feel a very small raised wire edge where the metal was pushed back slightly from the tip, much like bending aluminum foil. When you have a wire edge, it's time for polishing.
The final step to sharpening your tools is polishing. This doesn't mean to polish as you would chrome on your car. Instead, the purpose of this step is to remove the wire edge, and to give a final touch to cleaning up any tiny grooves that may remain in the face of the tool from the previous two steps.
Polishing can be done with an extremely fine wet stone, but I prefer to use a stropping wheel or leather. If you remember seeing a barber preparing a straight razor for shaving by sliding it along a leather stop, you have the idea. Stropping simply removes any imperfections in the cutting edge.
Some grinders (and wet grinders) have a leather stropping wheel. A stropping paste is applied to the wheel, which, combined with the motion of the wheel, will polish the tool and remove the final imperfections, getting it ready for use. The motion of the stropping wheel should always be with the grain of the tool toward the tip. In other words, if you were using a long stropping leather strap (like the barbers of old), you'd draw the tool backwards across the length of the leather. It doesn't take much - only a few seconds on the stropping wheel or strap to finely polish the tool and get it ready to go.
Testing the Tool:
To test the edge of the tool, I like to run it along the face of my arm, seeing how easily it will cut the hairs on my arm. Be careful not to cut yourself. Simply place the tool flat on your skin, and ease it forward, cutting into the hairs. A properly sharpened tool should cut through the hairs on your arm like a hot knife through butter.
If your tool isn't as sharp as you desire, you may need to repeat steps 2 & 3. I'd avoid grinding as much as possible, and if you take care of your tools, you probably will rarely need to grind them. But honing and polishing regularly will keep them in tip-top shape.