To animate layer content in timeline mode, you set keyframes in the Animation panel (Photoshop Extended CS5) or Timeline panel (CS6), as you move the current-time indicator to a different time/frame, and then modify the position, opacity, or style of the layer content. Photoshop automatically adds or modifies a series of frames between two existing frames—varying the layer properties (position, opacity, and styles) evenly between the new frames to create the appearance of movement or transformation.
For example, if you want to fade out a layer, set the opacity of the layer in the starting frame to 100% and click the Opacity stopwatch for the layer. Then move the current-time indicator to the time/frame for the ending frame and set the opacity for the same layer to 0%. Photoshop automatically interpolates frames between the start and end frames, and the opacity of the layer is reduced evenly across the new frames.
In addition to letting Photoshop interpolate frames in an animation, you can also create a hand-drawn frame-by-frame animation by painting on a blank video layer.