So for this one I first got the best source video I could find by doing the pwnyoutube trick (youtube.com/blah -> pwnyoutube.com/blah).

From there I grabbed a small slice of the general area of the clip I want with avidemux (using the lossless huffyuv codec)

Then I open the avi with VirtualDub, add a Null filter so I can crop the dimensions (this is because 1. Photoshop wont open the huffyuv, and 2. so Phosothop doesn't choke on loading too big of an avi), then save another avi

Then I open Photoshop and import -> video frames to layers.

After that I'll add text/adjust layers/delete frames etc.

In the Save For Web dialogue you can adjust number of colors, height and width to try and crunch stuff down.

I usually shoot for 1MB since that's about the max tumblr will take.