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Here's how Internet tracking works: You visit website A. Website A is being paid to display an advertising banner from LeftClick Inc. In addition to displaying the advertising banner, LeftClick also secretly plants a cookie on your computer with a unique ID number.
The following week you visit websites B and C, which also display LeftClick advertising banners. LeftClick reads that unique ID number back, and now knows that you've visited websites A, B, & C. Over months or years, they can potentially amass a list of thousands of visited sites and even determine how often you visit each.
By looking at the types of sites you visit, they can figure out what types of things you're interested in and start showing advertising banners targeted specifically at your interests.
As far as the website owners themselves, the answer is "sort of". A website owner cannot plant a cookie on your computer, let you surf the Internet, and then read your history back the next time you visit...that's a myth and an urban legend. What a site owner CAN do is determine how you got to their site, and how many times you've visited them. If you search for something on Google, for instance, and click a link to someones website, they can look at the REFERRER string in the HTTP headers and find out that your clicked to them from Google. They cannot, however, find out where you were before that.
Personally I've always regarded much of the cookie paranoia as little more than tinfoil hat conspiracies, and I've been using the Internet for well over a decade now. I mean, who CARES if some computer knows that I visited WebTender last night, or that I checked out Canon SLR lenses on eBay this afternoon, or even that I visit DU once or twice a day? I have yet to hear anyone offer any kind of convincing argument as to what actual evil lies in the fact that this knowledge exists. Besides, I can clear my cookies at any time with TWO CLICKS and render all of their careful tracking useless :)
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