It's been ages since the original OP posted, but reading this and using my friend Google did help me since I haven't used XP (or Windows) for a long time. Just in case anyone else is wondering how to do it:
1) Open your picture in MS Paint (or, if you have anything higher-tech, sure - why not)
2) Resize your picture to 32x32 pixels (I tested a file that wasn't resized but the end result was blurrier). I couldn't find the easy way to resize in Paint so just used the Image -> Stretch/Skew option and shrinking 80% a few times then cropped using Image -> Attributes to the size I wanted.
3) Save As 24-bit .bmp
4) Browse to the file just created and rename extension to .ico. If you can't see the extension after the filename in your explorer go to Tools -> Folder Options...; click on th View tab; uncheck Hide extensions for known file types
5) Right click on the existing icon and select properties
6) Click on Change icon and browse to the .ico file you just created
Done
)