Identity theft is when someone gets access to your personal information and uses it to impersonate you.  Usually this impersonation involves using your personal ID information and credit information to purchase things under your name.  Generally a person's identity is stolen by someone getting access to your social security number, credit card numbers, and/or your bank account numbers.  If an identity thief is skilled he can use one or two pieces of this information to find out everything about your current and past financial profile including all your credit card numbers and bank accounts.  Once your identity is stolen a thief can wipe out al of your accounts in a matter of days (if not minutes in some cases).
 
The best way to prevent identity theft is to take car of your personal information.  Don't give out passwords to people or write them down where they can be seen (or accessed on a computer).  If you want professional help a good source is LifeLock.  Lifelock offers a service (costs $10 to $15 per month) to protect you from identity theft and fraud up to $1 million and their fees are nominal.  Go to the website and check it out.