Two ways.
If it is sitting on your computer, you can attach it like you did, preview the post and copy the URL for the attachment then paste the URL into popup from "insert picture". I think you can then delete the attachment.
But your original attachment comes out huge when you do that.
If it's someplace like Picassa or Flikr or whatever, you need to find the link to the actual picture (somthing like
googleusercontent.com/-DlalXzGZY2s/TGr8W7aaCZI/AAAAAAAAAiI/eKvb0ZTvQVE/s400/SAM_0424.JPG)
and paste that in.
What works for me in Picassa is to check "Image only (no link)
", select the size, and copy what is in the imbed image box.