Avatars are a maximum of 100x100 pixels and a maximum of 10240 bytes. If it is 101 x (any number) or (any number) x 101 pixels it will be rejected, and if it is 10241 or more bytes it will be rejected.
It has to be a .gif or a .jpg (or .jpeg) file.
The best way is to place your avatar on your own website and reference it there at its own URL per that option in your preferences. I have limited space here overall and that is how I would prefer you do it, although you CAN upload it here and, if it meets the size limitations, and it should work.
Note that you cannot have your avatar refer to a file housed on your own hard drive unless your computer is configured and is active as a web server. I looked at your user configuration and you have not stored any avatar here or referenced one elsewhere.