A water bath is a technique used to moderate heat when baking custards such as flan, crème brûlée, crème caramel and timbales. It's basically just putting your custard pan into a larger one filled with hot water, and here's why it works: no matter the temperature of your oven, the water can't exceed 212°F (100°C), which is the temperature it boils and turns into steam. The water in the outer pan is heated by by the oven, but it's also being cooled as water molecules evaporate. Your custard will be resting in this moderate heat, ensuring a nice, smooth texture.
Preparing a water bath is easy but requires a little care. Select a large and deep aluminum, glass or cast iron pan that's large enough to hold your baking pan or ramekins. Pop in a wire rack and place your filled baking vessels on top of the rack. Then carefully place the pan in your preheated oven (you did preheat the oven, didn't you?). Carefully slide out the oven rack just a bit, then fill the lower pan with scalding hot water - just about halfway (or two-thirds) up the side of your ramekins or custard dish. Slip the oven rack back in (careful not to slosh the water) and close the oven door. Voilà! Your custard is now baking in a water bath. Don't worry too much about removing this contraption from the oven after baking - some of the water will evaporate.
You might be wondering why the directions above are so specific about equipment. Using an outer pan with good heat conductivity is important; the water in the "bath" must reach at least 185°FF (83°FC) to properly set your custard, so avoid stainless steel and ceramics. The wire rack is needed to make sure your custard pan doesn't come into direct contact with the outer pan. Don't substitute a folded towel for the rack; this will keep the water from circulating under the baking dish, cause the trapped water to boil, and jostle your custard around.
Now that you know the hows and whys of a water bath, try out one of the delicious baked custard recipes linked in the first sentence of this writeup. Bon appétit!
Harold McGhee, On Food and Cooking: The Science and Lore of the Kitchen (New York: Scribner, 2004), 96.
Irma Rombauer, Marion Rombauer Becker and Ethan Becker, Joy of Cooking: 75th Anniversary Edition (New York: Scribner, 2006), 801.