Here's how Apple describes it:
Sound Check is a feature introduced in iTunes 3 that allows you to hear all of your songs at approximately the same volume. You can turn Sound Check on and off in the Effects pane of iTunes preferences.
How it works
When Sound Check is on, iTunes scans the songs in your library and computes characteristics of their playback volume. As new songs are added, iTunes computes this information in the background. This data is stored in either the "normalization information" ID3 tag or the iTunes Music Library database. The audio data in your music files is never changed. If you encode or "rip" a song with iTunes, the sound check level is stored in the song's ID3 tags. For songs that were encoded with iTunes 1 or iTunes 2, or another application, the sound check levels are stored in the iTunes Music Library database.
When Sound Check is off
If you turn Sound Check off, the Sound Check data stored for each song is ignored, but not removed from the iTunes Music Library or the ID3 tags.
Notes
1. Sound Check works with .mp3, .wav, and .aiff file types. It does not work with other file types that iTunes 3 can play.
2. Any boosts in playback volume are protected against clipping by iTunes' built-in limiter.
Sound Check settings can be uploaded to iPod. However, the Sound Check settings can only be transferred to iPod when iTunes' Sound Check option is enabled.
iPod only uses these values if the Sound Check setting in iPod's Settings menu is set to On.
Note: MusicMatch Jukebox, included with iPod for Windows, has an feature called Volume Leveling that is similar to Sound Check. However, the Volume Leveling feature is not part of iPod for Windows Software 1.0. Using Volume Leveling has no effect when playing songs on iPod.
FWIW, I use it, and like it. I have a number of tunes that are wildly different from each other in volume. You can also (permanently) change the volume offset for each song manually by CTRL-click or right-clicking on a song in iTunes. Click on "Get Info", then "Options", then move the volume adjustment slider. Slick!
Cheers,
WCat