Knobby,
It basically uses some very sensitive coils, usually placed in the wing-tip because that's where they get the least interferance, to detect the earth's magnetic field. The detector is held in a "hook joint" which enables it to remain vertical as the aircraft banks and pitches.
The DI is connected to a similar set of coils, which are connected to the detector in such a way that a current is produced if the two are not aligned. This current is used to turn the DI. When it aligned with the detector unit, no current is generated and so the DI remains stationary. As it drifts (which all DIs will do, as we've discussed) a current is produced and it synchronises itself again.
The DI is normally aligned at a rate of 2 degrees per second. However, there is a "fast" mode for initial alignment when it is first turned on (or after it topples). I also recall something about the detecting unit being ignored at high angles of bank, and it basically becomes a standard DI, which then re-syncronises itself with the detecting unit when the aircraft is rolled level again - but I can't find anything about that in my notes.
Hope that helps!
FFF
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