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Mipmap Edited Spray Effect

Tools needed:

Photoshop
Nvidia Photoshop Plugin
DirectxSDK
VTFedit
Quick & Dirty Bloodlines Tools v3.9a

Alternative tools:

GIMP
DDS Plugin

Abilities needed:

How to create alpha masked TGA's,
How to import and export VTF files in VTFedit,
The really basic stufffffff.

Steps:

1.
To start making this effect for your sprays you need two images, one which will be your far image and another for your close up.

2.
Take your far image into photoshop and proceed to edit it like you would with a png, removing the background onto transparency and that type of thing, once this is done save your far image as a DDS, this is where the Nvidia plugin comes into play as it allows you to save images in the DDS format.

Remember, your images MUST be a power of 2, eg. 256x256 or 512x512.

3.
When saving in the DDS format make sure you have the drop down menu selected to DXT5 and not DXT5_NM, once you have it on the right format save your DDS to somewhere you will remember.

4.
Open your close up image, here you will need to process your image like you would with a TGA, for transparency you will be required to create a alpha mask.
Once this is done and you are happy with the image save it as a 32 bit TGA.

Remember, your images MUST be a power of 2, eg. 256x256 or 512x512.

5.
Open up your DDS in the DirectX Texture Editor, this will be found in where you installed the SDK under DirectX Utilities.
Once in the editor go to the LARGEST mipmap, once on the largest mipmap you then need to import your close up TGA image.
To do this go to File > Open onto this surface...
Navigate to your TGA and import it, now you will find when you cycle through the mipmaps the largest one will be different to the others, this is what creates the fade effect.
Save your edited DDS.

6.
Open up Quick & Dirty Bloodlines Tools v3.9a (DDS to VTF (IMPORTANT SHIT BRO).exe) and open the texture tools tab, here you will find a fair few options being displayed, ignore them.
Open your DDS with Quick & Dirty, once the file has been opened by the program check any of the boxes you want (even though it's better not too).
Finally press Convert DDS to VTF.

7.
You will now find a VTF saved next to where your DDS is, load up VTFedit and open the VTF.
Cycle through the mipmaps to make sure the conversion was successful, if not start from step 5 again.
If it was successful, in VTFedit go to Options and make sure Auto Create VMT File is checked, if it is not, check it.
Finally go to File > Save as and navigate to your steamapps\username\team fortress 2\tf\materials\VGUI\logos folder, this is typically found where you installed steam.

8.
Go in-game and select your new spray.

9.
Spray it on a wall and stare in amazement as you walk around it

Known Issues:

Spray does not fade

This is sometimes down to your graphics settings being too low or you ignored step 6.

Spray does not display correct to everyone

This is sometimes down to their graphics settings being too low or you ignored step 6.
Or sometimes it is down to the server not uploading the spray correctly to the client, this is sometimes solved by rejoining.

Alternatives:

It is possible to do this with paint.net as I have heard, but I am not 100% sure how reliable the DDS plugin for it is.