Image Blending in Photoshop

1.First, load a new image. I created a new document and pasted this image onto a new layer, but it could just as well be the default background layer. This will be our "base" image.

Image1

2.Load up another image and paste it into the first image. A new layer will automatically be created. Rename the layers to Image1 and Image2 if you'd like.

Image2

3.Your Layers Palette should now have two layers, each with the images you loaded. If you don't see the layers palette, use the Window>Layers menu (or press F7). Now, click the top layer (in this case, "Image2") to make it the active layer. In the next step, we'll be creating a mask for this layer so it can blend through to the layer below it.

Layer Palette

4.There are many ways to create a mask, but the easiest way is to turn on "Quick Mask Mode". In this mode, anything you draw will be become your mask. Press the q button on your keyboard, or click the quick mask mode icon (Quickmask Mode) near the bottom of the tool bar to enter quick mask mode. Now, since we want to fade two images into eachother, I'll create a vertical gradient, from white (representing 100% opacity) to black (0% opacity) using the gradient tool (Gradient Tool). While in quick mask mode, the gradient you create will be displayed in shades of red so you can better see it . After using the gradient tool, you should now see something like the image below.

Image2 layer with quickmask

5.Now that we've drawn the gradient quick mask, we go back into "standard mode" by pressing the q key once again or by clicking the standard mode icon (Standard Mode) near the bottom of the tool bar. This will create a selection based on the quick mask, which we'll use in the next step.

Note: if you're wondering why the selection looks like it's only covering half of the image, that's because photoshop only draws a selection around the parts that have more than 50% opacity.
Image2 layer with quickmask selection

6.Our next task is to apply the mask we've just created to the top layer. This will allow the layer to control its transparency based on the mask. To do this, all you have to do is click the "Add Layer Mask" button (Add Layer Mask) on the layers palette. Your layers palette should look like the image below.

Layer Palette with mask applied

7.That's all there is to it. You should now see your two images smoothly blended together like the image below.

Final Image