Creating your own colorwork knitting projects is really a lot of fun and I encourage everyone to try it. Here's one of my first efforts for a child's garden leaves hat with a picket fence around the cuff.
Before you start I'd recommend knitting a few stranded color knitting patterns so you understand the basics. It is helpful to understand how to deal with long floats, tension issues, and the inevitable color pattern jogs that occur at the end of the row. If you want to design a pattern that uses 3 or more colors per row or is knit flat it is good to know that these colorwork methods are more difficult to knit. Also, it is a good idea to understand the difference between intarsia and stranded color knitting so you understand what will work in a stranded chart pattern and what is better done with intarsia.
The easiest way to make charts is to use graph paper and colored pencils. Most graph paper you buy at the office supply place is square which is okay but generally the knitted stitch is a rectangle. (In stranded color knitting the knitted stitch is actually closer to a square because the floats pull in the stitches but it still depends on the yarn and gauge and pattern, etc. Once I knitted a cross stitch pattern and the end result looked nothing like it did on the chart.)
To get graph paper that is exactly the same size as your stitches, you can use this free online graph paper. You simply add in the calculations from your gauge swatch and then you print out graph paper that is the same size as your knitted stitches.
If you want to share your stranded knitting patterns with others you're probably going to want another method of creating charts. You can use Microsoft Excel; Marnie MacLean wrote an excellent tutorial on how to do this HERE.
Software used specifically to create needlework charts varies in price from free to several hundred dollars. If you don't mind squares, HERE is a free program for counted cross stitch software. Denise's Needleworks (also a great source for Rauma patterns) sells a knitter's chart software for $10. This program also generates only squares and the link includes a free demo you can try.
I personally use Stitch and Motif Maker. I found the best price at Knitpicks and it is drop dead easy to use. There's a little tutorial and when you're done you completely understand the program. There's a free demo of the program HERE.
Two other programs to look into are Knit Visualizer and Stitch Painter. They both have free demos you can download as well.
Once you have the ability to make a chart then you can start creating a design. You can simply start playing around with patterns or you can find some charts. Most Fair Isle and Norwegian books contain lots of charts for color knitting - my two personal favorites are the inexpensive reprints of Sheila McGregor's Traditional Scandinavian Knitting and Traditional Fair Isle Knitting. There are also many knitting charts online - check HERE for a zillion Latvian mitten and glove patterns and HERE for some lovely Scandinavian charts.
Finally I want to provide links to two fun free online programs: KnitPro generates a color chart from any .JPG image and Palette Generator provides a color palette from any photo.