HaTcH suggested this trick to me and I thought I'd explain it in a bit more detail, since there's a bit of an AMV trend going on in bits of the Zoids fandom. This assumes you already have some idea how to make amvs...a guide for those would be a whole other kettle of fish. I'm also not the most knowledgable person out there, I'll admit...I'm just passing on what works for me.
Of course, if your source video is bad quality, this won't help it much, but it'll at least make for nicer audio :p.
Select "other settings", then "DV-AVI (NTSC)". Hit next again. Wait for your video to save.
DV-AVI's quality makes it easier to spot errors *before* you go through the trouble of squishing a vid further and uploading, so it's probably a good idea to watch your video now too.
The first box will ask you for a source-hit browse and find your DV-AVI file. By default, the output will be the same name, but you can make it whatever you want, of course. Hit next.
It'll ask you how you're distributing your content. Hit "File download (computer playback)".
Next it'll give you a box with how to encode. Ignore that for now-as it says, you change them in Session Properties when done with the wizard. Hit next again.
Now you can fill in a title, author, and the like. These show in WMP and possibly other players. I always put in at least a title and author. Hit next.
Look to make sure your settings (other than bitrate) are correct, uncheck begin converting when I click Finish, and hit finish.
Go to compression, then the heading "Bit rates". You'll see 5393 kbps, which is silly. Highlight it and press Edit. Ignore the General tab unless you know what you're doing with the audio/video modes and have a pressing need to change them, and go to the second tab with 5393 kbps on it.
Select audio format 128 kbps, 48 kHz, 2 channel 24 bit VBR. You can select a higher bitrate if your music demands it, but it'll make the file larger.
Video size you want 320x240. Leave frame rate and the other stuff alone.
Video bitrate is a matter of personal choice. I use 500 for clips, and 700 or so for amvs. You can always try several and see what the best tradeoff between quality and file size is.
Now, hit okay, and check to make sure you have the right settings in Details.
You can watch the input and output video while you wait, but output won't show on the first pass.
Once the video's done, you can close Windows Media Encoder...it'll ask you if you want to save the session. You can if you want to go back to those settings later, but you'll have to change the source/output/title to suit the next thing you make.
Or something.