1: The first thing you will want to do is find a good source image. High-contrast images in particular work very well for this method.
2: Load the image into Photoshop (or your graphic editing software of choice) and cut the person or object out of your source image using whatever tool you are comfortable with (magic wand, pen tool, eraser, etc.)
3: Use CTRL+U to bring up the Hue/Saturation panel. From here, you should bring saturation completely down to make the image completely black+white. After this, use ctrl+L to bring up the Levels panel. From here you should use the sliders to darken your blacks and lighten your whites. What you?re going for is a high-contrast image.
4: Use Select -> Color Range to select all of the white left in your picture. After you have done this, hit the delete key to delete the white, so that you are only left with black.
5: From here, hit ctrl+L again, and use the levels to make your blacks as dark as possible (so that it almost looks like a bad photocopy)
6: Add some text (if necessary), and proceed to crop the image (with the crop tool) to the very edges of its boundaries.
7: Now, head up to Image -> Canvas size, and resize your document. The document must be a power of x2 (ie: 64x64, 128x512, 256x256, etc). My document is 324x421 so I will use 512x512
8: Hide your text layer, hold down control, and click on your black layer to select everything on that layer.
9: Proceed to create a new layer, switch to the brush tool, and find the 'chalk' brush. Change your palette over to the two colors you want (chalk brush uses both). Use this brush to lightly paint over your selection.
10: Do the same thing for your text:
11: Now make another new layer, and move it underneath your other layers. select all (ctrl+a) and go to edit->fill-> 50% gray
12: Now for the alpha channel. Hide the gray layer you just created. Go to the channels tab, and find a color channel that is mostly black (in my case, the blue channel). Right click on that channel and duplicate it. Name the new channel "Alpha Channel". Finally, hit ctrl+i to invert this channel
When working with more complex transparencies (gradients, color layers, etc.) it is important to understand how an alpha channel works. Remember, everything that is black is going to be transparent, and white will be completely solid. Everything in between will be varying levels of transparency.
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13: Switch back over to your layers and un-hide that gray layer. Now simply save your image as a 32-bit targa (.tga) file. This image is now ready to be converted for use as an alpha-channeled material in Source.
14: Proceed to copy your file to the following directory:
SteamSteamAppsYourUserNamesourcesdk_contenthl2materialsrcYour file name
(in this example you will have to create the folder that is in the materialsrc folder and it's name is irrelevant)
15: Proceed to the following directory:
SteamSteamAppsYourUserNamesourcesdkbin
and find the executable "vtex.exe"
16: Right-click on vtex.exe and create a shortcut to it. Proceed to right-click on the shortcut and go to its properties.
17: From here, add the following to the 'target' information (after what is already there):
-mkdir -shader lightmappedgeneric c:valvesteamsteamappsyourusernamesourcesdk_contenthl2materialsrcyourfoldername*.tga
18: Double-click on the shortcut you have just created, and a small DOS window should show up. Check the text for error messages, and if none are present than all is well. Once it is complete you may close it.
If you have encountered an error, than you have not set your targa up correctly and should refer to the guide I have created for setting up your targa file.
19: Proceed to the following directory:
SteamSteamAppsYourUserNamehalf-life 2hl2materialsYourFolderName
in here you should see two files you have created, one a .vmt and one a .vtf
20: Open the .vmt file with any text-editing program (notepad works fine). You should see something like this
21: This is fine for a basic material, but we need to tell this material a few things.
First, we need to tell this material to use it's alpha channel. Second, we need to tell the material that it is going to be used as a decal. Third, we need to set it's scale. We can do these things by adding these 3 lines of code:
22: Finally, fire up Hammer, find your material, and apply it to any surface with either the decal or overlay tool- now you're done!
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2: Load the image into Photoshop (or your graphic editing software of choice) and cut the person or object out of your source image using whatever tool you are comfortable with (magic wand, pen tool, eraser, etc.)

3: Use CTRL+U to bring up the Hue/Saturation panel. From here, you should bring saturation completely down to make the image completely black+white. After this, use ctrl+L to bring up the Levels panel. From here you should use the sliders to darken your blacks and lighten your whites. What you?re going for is a high-contrast image.

4: Use Select -> Color Range to select all of the white left in your picture. After you have done this, hit the delete key to delete the white, so that you are only left with black.
5: From here, hit ctrl+L again, and use the levels to make your blacks as dark as possible (so that it almost looks like a bad photocopy)

6: Add some text (if necessary), and proceed to crop the image (with the crop tool) to the very edges of its boundaries.
7: Now, head up to Image -> Canvas size, and resize your document. The document must be a power of x2 (ie: 64x64, 128x512, 256x256, etc). My document is 324x421 so I will use 512x512

8: Hide your text layer, hold down control, and click on your black layer to select everything on that layer.

9: Proceed to create a new layer, switch to the brush tool, and find the 'chalk' brush. Change your palette over to the two colors you want (chalk brush uses both). Use this brush to lightly paint over your selection.

10: Do the same thing for your text:

11: Now make another new layer, and move it underneath your other layers. select all (ctrl+a) and go to edit->fill-> 50% gray

12: Now for the alpha channel. Hide the gray layer you just created. Go to the channels tab, and find a color channel that is mostly black (in my case, the blue channel). Right click on that channel and duplicate it. Name the new channel "Alpha Channel". Finally, hit ctrl+i to invert this channel
When working with more complex transparencies (gradients, color layers, etc.) it is important to understand how an alpha channel works. Remember, everything that is black is going to be transparent, and white will be completely solid. Everything in between will be varying levels of transparency.
[

13: Switch back over to your layers and un-hide that gray layer. Now simply save your image as a 32-bit targa (.tga) file. This image is now ready to be converted for use as an alpha-channeled material in Source.
14: Proceed to copy your file to the following directory:
SteamSteamAppsYourUserNamesourcesdk_contenthl2materialsrcYour file name
(in this example you will have to create the folder that is in the materialsrc folder and it's name is irrelevant)
15: Proceed to the following directory:
SteamSteamAppsYourUserNamesourcesdkbin
and find the executable "vtex.exe"
16: Right-click on vtex.exe and create a shortcut to it. Proceed to right-click on the shortcut and go to its properties.
17: From here, add the following to the 'target' information (after what is already there):
-mkdir -shader lightmappedgeneric c:valvesteamsteamappsyourusernamesourcesdk_contenthl2materialsrcyourfoldername*.tga
18: Double-click on the shortcut you have just created, and a small DOS window should show up. Check the text for error messages, and if none are present than all is well. Once it is complete you may close it.
If you have encountered an error, than you have not set your targa up correctly and should refer to the guide I have created for setting up your targa file.
19: Proceed to the following directory:
SteamSteamAppsYourUserNamehalf-life 2hl2materialsYourFolderName
in here you should see two files you have created, one a .vmt and one a .vtf
20: Open the .vmt file with any text-editing program (notepad works fine). You should see something like this
"lightmappedgeneric"
{
"$baseTexture" "yourfoldername/gman_is_evil"
}
First, we need to tell this material to use it's alpha channel. Second, we need to tell the material that it is going to be used as a decal. Third, we need to set it's scale. We can do these things by adding these 3 lines of code:
"lightmappedgeneric"
{
"$baseTexture" "yourfoldername/gman_is_evil"
"$translucent" 1
"$decal" 1
"$decalscale" "0.25"
}
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