A contextual ad for "The Office". Photo by James O'malley
Contextual advertising is based on an automated system that scans the text of a web site for keywords and return advertisements to the web page based on the subject matter the user is viewing. For example, if a user is viewing a web site related to shoes, and the web site uses contextual advertising, the user might see advertisements for shoes, socks, or other footwear related products.
Contextual advertising is also used by the major search engines (Google, MSN, Ask.com) to display advertisements on their search results pages based on the keywords in the user's search query.
Contextual advertising does have some problems, currently. The biggest one being third party hyper-linking, where a third party installs software onto a user's computer and the software interacts with the browser by turning keywords on a web page into hyperlinks leading to advertisers, who are not paying the web site to advertise on its pages.
This is a major drawback. However, the effectiveness of having well targeted search queries and pages to advertise on with relevant content, make using contextual advertising a very effective Internet marketing strategy.
For more Internet Marketing tips, read: Internet Marketing 101: What is cost per action marketing?