A looped sound will repeat endlessly without any gap between its end and start. It is up to the sound artist to ensure that the end and start of the file match up however, or there will be a "pop" as the waveform jumps from one shape to another.
Source detects looped sounds ONLY through cue points embedded in the file. This is a WAV-only feature, so MP3s cannot be looped. MS-ADPCM compressed WAVs can be looped, but due to the compression there will be a pop when the sound restarts.
These free programs can add cue points to a WAV:
GoldWave
Cue location
Your cues do not have to be at the start and end of the file. If you place them in the middle Source will start playing the sound normally, then when it reaches the end cue will loop back to the start cue. From then on only what's between the cues will play.
This can be used to give a sound a "winding up" effect that only plays once (e.g. a motor starting).