Otaku, meaning probably "venerable house," refers to someone who has a devotion to a subject or hobby (not necessarily anime) to the point of not leaving home. For instance, an otaku fan of a particular movie star could quite possibly know all of the films s/he has been in, their birth date, time of birth, shoe size, favorite toothpaste, etc. Generally speaking, calling someone an otaku in Japan is an insult, implying that their social skills have atrophied or never even developed, due to their manic involvement in their chosen fandom.
In America, the term is used to denote a zealous fan, usually of anime and/or manga. Due to its introduction to most people's vocabulary through its tongue-in-cheek use in Gainax's film, "otaku" tends to have a much less dire definition overseas.
When dealing with Japanese people, however, it may be best to keep in mind the modern Japanese image of an otaku -- Someone who only leaves their home to eat or shop, if at all, with an overwhelming and unhealthy obsession about something. It can as easily refer to a stalker or sociopath as it can to a harmless anime buff.
Best to avoid the word altogether if one is not sure of the context in which it will be received.
Negative: "Stay clear of Toshi, man. He's such a RQ otaku, always online. Bet he's never actually even talked to a real-live girl before... You never know when he's gonna' snap, right?"
Otaku is extremely negative in meaning as it is used to refer to someone who stays at home all the time and doesn't have a life (no social life, no love life, etc)
Usually an otaku person has nothing better to do with their life so they pass the time by watching anime, playing videogames, surfing the internet (otaku is also used to refer to a nerd/hacker/programmer).
In the Western culture, people confuse otaku to be something positive like "Guru". If you think about it, it's not really good to be called a guru if it means you are a total loser who can't socialize with other people except through the Internet.
Other Japanese words which have been confused by Westerners also include but not limited to: Anime, Manga, etc
In Japan the word "otaku" has become taboo because of Miyazaki Tsutomu who went on a toddler murdering spree in the 80's, video taping the young girls he had murdered from an obsession with lolicon (female pedophilic manga).
Americans use this term to call themselves "fanboys" or "fangirls" with almost no knowledge of the horrific roots behind the word.
Non-anime fan: "...Uhm, you do know about that word right?"
This is a high-context word, in the american dialect, given the type of people using the word and the context of the discussion this OTAKU could mean expert or geek, complemetary or derogatory.
ELSEWHERE: Out of Japan is the term "Otaku" used in the meaning of hardcore fan of anime and Manga. Many of anime fans call themselves otaku despite knowing it's meaning in Japan.
In America, the term has been embraced by anime fans, who (as they do with many Japanese words), use the word incorrectly as a positive term for fanboy/girl.
2. "I, like, so totally love Sailor Moon! Serena rawks! I am, like, the ultimate Sailor Moon otaku!"