Image from MacCulloch & Wallis»
Tracing wheels are usually a blunt, serrated edge or needle point style wheel on a wooden or plastic handle. They are used for transferring markings between patterns, or between patterns and fabric. The example tracing wheel in the image is an example of a needle point tracing wheel, and is also ideal for tracing markings from toiles back onto patterns in order to make pattern adjustments.
The blunt ones can be used for tracing with carbon paper to mark off one pattern onto another paper or piece of cardboard.
The serrated or spiked wheels are the ones most commonly used in pattern making which pierce a line of small holes through from one layer of paper or cardboard onto the layer underneath.
Tracing wheels also allow you to trace off sections of toiles which you have draped on a mannequin onto paper or cardboard for a final pattern.
Tracing wheels can also be used with carbon paper directly onto fabrics to mark out lines and markings where needed, such as dart arms or pleat placements. Always check that your wheel is not damaged first to avoid damaging your final fabric.
Note: This post was updated with a new tracing wheel image and link on the 16th October 2013.