Digital circuits generate current spikes as they switch - this causes voltage ripples on the supply lines, effecting all components around.
Decoupling means stopping this current spike drawing power from the power lines.
The decoupling capactior, placed near each chip across its power lines (Vcc to Gnd) supplies this transient current to the chip instead of the power lines, thus eliminating the ripples on the supply. The capacitor then recharges slowly from the supply line, ready for the next transient.
Usually, a ceramic capacitor of 10nF to 100nF placed immediately next to each chip, from Gnd to Vcc, is used. In addition, a larger capacitor, 10uF to 100uF, may be used at the power connection to the board, with a smaller ceramic one, 100nF, in parallel to absorb higher frequency transients.
Cheers,
FoxyRick.